10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period endedSeptember 30, 2008

1-32146

Commission file number

DOCUMENT SECURITY SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

New York	16-1229730
(State of incorporation)	(IRS Employer Identification Number)

28 Main Street East, Suite 1525

Rochester,NY14614

(Address of principal executive office)

(585) 325-3610

(Registrant's telephone number)

Indicate by check mark whether the registrant:

(1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports)

And

(2) has been subject to such filing requirements for the past 90 days.

Yes x  No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Yes ¨  No x

Applicable only to corporate issuers

As of November 7, 2008 (the most recent practicable date), there were 14,472,994 shares of the issuer's Common Stock, $0.02 par value per share, outstanding.

DOCUMENT SECURITY SYSTEMS, INC.

FORM 10-Q

TABLE OF CONTENTS

PART I	FINANCIAL INFORMATION
Item 1	Financial Statements
	Consolidated Balance Sheets	3
	Consolidated Statements of Operations	4
	Consolidated Statements of Cash Flows	5
	Notes to Interim Consolidated Financial Statements	6
Item 2	Management's Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3	Quantitative and Qualitative Disclosures about Market Risk	23
Item 4	Controls and Procedures	23
PART II	OTHER INFORMATION
Item 1	Legal Proceedings	23
Item 1a	Risk Factors	25
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	30
Item 3	Defaults upon Senior Securities	30
Item 4	Submission of Matters to a Vote of Security Holders	30
Item 5	Other Information	30
Item 6	Exhibits	31
SIGNATURES

2

PART I

FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

DOCUMENT SECURITY SYSTEMS, INC.  AND SUBSIDIARIES

Consolidated Balance Sheets

As of

	September 30,			December 31,
	2008			2007
	(unaudited)			(audited)
ASSETS
Current assets:
Cash and cash equivalents	$	442,803		$	742,468
Restricted cash		157,500			-
Accounts receivable, net of allowance of $65,000 ($82,000 as of December 31, 2007)		784,668			617,320
Inventory		230,272			259,442
Loans to employees		67,781			120,732
Prepaid expenses and other current assets		87,906			487,715
Total current assets		1,770,930			2,227,677
Restricted cash		-			177,345
Fixed assets, net		1,349,230			1,494,540
Other assets		258,085			147,958
Goodwill		1,396,734			1,396,734
Other intangible assets, net		3,580,285			6,149,530
Total assets	$	8,355,264		$	11,593,784
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	1,353,926		$	1,795,085
Accrued expenses & other current liabilities		1,112,404			818,606
Deferred revenue & customer deposits		56,580			732,355
Current portion of capital lease obligations		84,129			79,948
Total current liabilities		2,607,039			3,425,994
Revolving notes from related parties		1,858,000			300,000
Capital lease obligations		215,229			294,821
Deferred revenue		-			15,938
Deferred tax liability		203,397			200,000
Commitments and contingencies (see Note 10)
Stockholders' equity
Common stock, $.02 par value; 200,000,000 shares authorized, 14,359,756 shares issued and outstanding (13,654,364 in 2007) (325,000 subscribed in 2008)		287,195			273,087
Additional paid-in capital		34,881,064			31,298,571
Subscriptions receivable		(1,300,000	)		-
Accumulated deficit		(30,396,660	)		(24,214,627	)
Total stockholders' equity		3,471,599			7,357,031
Total liabilities and stockholders' equity	$	8,355,264		$	11,593,784

See accompanying notes

3

DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
Revenue
Security printing and products	$	1,334,184		$	945,941		$	3,421,437		$	2,764,323
Royalties		181,047			278,290			1,401,522			871,243
Digital solutions		8,220			9,469			24,660			184,240
Legal products		150,129			175,725			482,561			513,070
Total Revenue		1,673,580			1,409,425			5,330,180			4,332,876
Costs of revenue
Security printing and products		635,934			635,935			2,027,636			1,691,473
Digital solutions		3,507			3,507			10,521			40,521
Legal products		86,120			82,575			257,536			276,342
Total costs of revenue		725,561			722,017			2,295,693			2,008,336
Gross profit		948,019			687,408			3,034,487			2,324,540
Operating expenses:
Selling, general and administrative		1,789,790			1,979,171			5,828,136			5,587,903
Research and development		72,876			110,833			322,106			314,130
Impairment of patent defense costs		-			-			291,581			-
Amortization of intangibles		540,934			480,256			1,605,104			1,258,985
Operating expenses		2,403,600			2,570,260			8,046,927			7,161,018
Operating loss		(1,455,581	)		(1,882,852	)		(5,012,440	)		(4,836,478	)
Other income (expense):
Interest income		484			14,829			569			89,816
Gain (loss) on foreign currency transactions		7,534			(6,378	)		(16,652	)		(10,669	)
Interest expense		(41,208	)		(1,362	)		(95,098	)		(3,811	)
Loss on sale of patent assets		(1,169,947	)		-			(1,169,947	)		-
Other Income		-			-			125,795			-
Loss from continuing operations before income taxes		(2,658,718	)		(1,875,763	)		(6,167,773	)		(4,761,142	)
Income tax expense		4,738			4,738			14,260			14,214
Loss from continuing operations		(2,663,456	)		(1,880,501	)		(6,182,033	)		(4,775,356	)
Loss from discontinued operations (Note 8)
Gain on sale of discontinued assets					42,905						42,905
Loss from discontinued operations		-			(43,807	)		-			(59,233	)
Loss on discontinued operations		-			(902	)		-			(16,328	)
Net loss	$	(2,663,456	)	$	(1,881,403	)	$	(6,182,033	)	$	(4,791,684	)
Net loss per share -basic and diluted:
Continuing operations	$	(0.19	)	$	(0.14	)	$	(0.45	)	$	(0.35	)
Discontinued operations		(0.00	)		0.00			(0.00	)		0.00
Net Loss	$	(0.19	)	$	(0.14	)	$	(0.45	)	$	(0.35	)
Weighted average common shares outstanding, basic and diluted		14,286,192			13,676,030			13,879,891			13,629,241

See accompanying notes

4

DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30,

(unaudited)

	2008			2007
Cash flows from operating activities:
Net loss	$	(6,182,033	)	$	(4,791,684	)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization		1,841,975			1,396,262
Stock based compensation		1,536,403			970,829
Impairment of patent defense costs		291,581			-
Net gain on disposal of discontinued operations		-			(42,905	)
Loss on sale of patent assets		1,169,947			-
Decrease in restricted cash		19,845			-
(Increase) decrease in assets:
Accounts receivable		(167,348	)		(112,870	)
Inventory		29,170			4,762
Prepaid expenses and other assets		(43,049	)		(171,526	)
Increase (decrease) in liabilities:
Accounts payable		(65,053	)		445,334
Accrued expenses and other liabilities		143,914			(25,635	)
Deferred revenue		(691,713	)		(234,464	)
Net cash used by operating activities		(2,116,361	)		(2,561,897	)
Cash flows from investing activities:
Purchase of fixed assets		(226,716	)		(423,918	)
Proceeds from the sale of discontinued operations		-			80,000
Proceeds from the sale of patent assets		500,000			-
Purchase of other intangible assets		(1,144,351	)		(1,150,977	)
Net cash used by investing activities		(871,067	)		(1,494,895	)
Cash flows from financing activities:
Borrowing on short-term credit facility		500,000			-
Repayment on short-term credit facility		(500,000	)		-
Borrowing on revolving note- related parties		1,558,000			-
Repayments of capital lease obligations		(75,411	)		(27,140	)
Increase in restricted cash		-			(177,345	)
Payment of stock issuance costs		-			(519,619	)
Issuance of common stock		1,205,174			355,225
Net cash provided (used) by financing activities		2,687,763			(368,879	)
Net increase (decrease) in cash and cash equivalents		(299,665	)		(4,425,671	)
Cash and cash equivalents beginning of period		742,468			5,802,615
Cash and cash equivalents end of period	$	442,803		$	1,376,944

See accompanying notes.

5

DOCUMENT SECURITY SYSTEMS, INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2008

(Unaudited)

1.     Basis of Presentation and Significant Accounting Policies

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, the accompanying balance sheets and related interim statements of operations and cash flows include all adjustments, consisting only of normal recurring items necessary for their fair presentation in accordance with U.S. generally accepted accounting principles. All significant intercompany transactions have been eliminated.

Interim results are not necessarily indicative of results expected for a full year. For further information regarding Document Security Systems, Inc (the “Company”) accounting policies, refer to the audited consolidated financial statements and footnotes thereto included in the Company's Form 10-K for the fiscal year ended December 31, 2007.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates and assumptions.

Other Intangible Assets– Other intangible assets consists of costs associated with the application, acquisition and defense of the Company’s patents, contractual rights to patents and trade secrets associated with the Company’s technologies, a non-exclusive licensing agreement, and customer lists obtained as a result of acquisitions. The Company’s patents and trade secrets are for document anti-counterfeiting and anti-scanning technologies and processes that form the basis of the Company’s document security business. External legal costs incurred to defend the Company’s patents are capitalized to the extent of an evident increase in the value of the patents and an expected successful outcome. Legal costs are expensed at the point when it is determined that the outcome is expected to be unsuccessful. The Company capitalizes the cost of an appeal until it is determined that the appeal will be unsuccessful. The Company’s capitalized patent defense costs expenses are analyzed for impairment based on the expected eventual outcome of the legal action and recoverability of proceeds or added economic value of the patent in excess of the costs. Legal actions related to the same patent defense case are unified into one asset group for the purposes on the impairment analysis. The Company amortizes its other intangible assets over their estimated useful lives. Patents are amortized over the remaining legal life, up to 20 years. Intangible asset amortization expense is classified as an operating expense.

Recent Accounting Pronouncements In September 2006, the FASB issued SFAS No.157, Fair Value Measurements. SFAS No. 157, as amended, defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States of America, and expands disclosures about fair value measurements. With respect to financial assets and liabilities, SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. However, in February 2008, the FASB determined that an entity need not apply this standard to nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis until 2009. Accordingly, the Company’s adoption of this standard on January 1, 2008, is limited to financial assets and liabilities and did not have a material effect on the Company’s financial condition or results of operations. The Company’s still in the process of evaluating the impact of this standard with respect to its effect on nonfinancial assets and liabilities and has not yet determined the impact that it will have on the consolidated financial statements upon full adoption.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which permits entities to choose to measure certain financial assets and liabilities at fair value. SFAS No. 159 is effective for years beginning after November 15, 2007. The Company has not adopted the fair value option method permitted by SFAS No. 159.

6

In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”), which replaces SFAS 141. SFAS 141R establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R is to be applied prospectively to business combinations for which the acquisition date is on or after an entity’s fiscal year that begins after December 15, 2008. We are currently evaluating the potential impact of the adoption of SFAS 141R on our consolidated financial position, results of operations and cash flows.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements-on Amendment of ARB No. 51. SFAS No. 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary. SFAS No. 160 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim statements within those fiscal years. Among other things, SFAS No. 160 requires noncontrolling interest to be included as a component of shareholders’ equity. The Company does not currently have any noncontrolling interests.

On December 21, 2007, the SEC issued Staff Accounting Bulletin No. 110, “Share-Based Payment”. SAB No. 110 addresses the use of a “simplified” method in developing an estimate of expected term of “plain vanilla” share options in accordance SFAS No. 123(R), “Share-Based Payment”. SAB No. 110 allows the use of the “simplified” method of estimating expected term where a company may not have sufficient historical exercise data. SAB No. 110 is effective January 1, 2008 and the Company plans to continue to use the simplified method to estimate the expected term of its plain vanilla employee options.  

On December 12, 2007, the Financial Accounting Standards Board (FASB) ratified the Emerging Issues Task Force (“EITF”) opinion related to EITF Issue 07-1, “Accounting for Collaborative Arrangements.” The Task Force reached a consensus that a collaborative arrangement is a contractual arrangement that involves two or more parties, all of which are both (a) involved as active participants in a joint operating activity that is not conducted primarily through a separate legal entity and (b) exposed to significant risks and rewards that depend on the commercial success of the joint operating activity. This Issue also addresses (i) the income statement classification by participants in a collaborative arrangement for transactions with third parties and transactions between the participants and (ii) financial statement disclosures. The consensus on EITF Issue 07-1 is effective for fiscal years beginning after December 15, 2008, and for interim periods within those fiscal years. Entities should apply the consensus retrospectively to all periods presented for only those collaborative arrangements existing as of the effective date, unless it is impractical to do so. The Company will adopt this new accounting pronouncement effective January 1, 2009, and does not anticipate any material impact on its financial condition or results of operations.

In April 2008, the FASB issued FSP FAS 142-3, “Determination of Useful Life of Intangible Assets” (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing the renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FAS 142, “Goodwill and Other Intangible Assets.” FSP FAS 142-3 also requires expanded disclosure related to the determination of intangible asset useful lives. FSP FAS 142-3 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the potential impact the adoption of FAS FSP 142-3 will have on its financial statements.

In May 2008, the FASB issued FASB Staff Position (“FSP”) APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP APB 14-1”), which clarifies the accounting for convertible debt instruments that may be settled in cash upon conversion, including partial cash settlement. FSP APB 14-1 specifies that an issuer of such instruments should separately account for the liability and equity components of the instruments in a manner that reflect the issuer’s non-convertible debt borrowing rate when interest costs are recognized in subsequent periods. FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008, and retrospective application is required for all periods presented. The Company is currently evaluating the potential impact of the adoption of FSP APB 14-1 on its financial statements.

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles. The purpose of this statement is to improve financial reporting by providing a consistent framework for determining applicable accounting principles to be used in the preparation of financial statements presented in conformity with accounting principles generally accepted in the United States of America. SFAS No. 162 will become effective 60 days after the SEC’s approval. The Company believes that the adoption of this standard on its effective date will not have a material effect on the consolidated financial statements

7

In June 2008, the FASB issued FSP EITF 03-6-1 to address whether instruments granted in share-based payment transactions are participating securities prior to their vesting and therefore need to be included in the earnings per share calculation under the two-class method described in SFAS No. 128, “Earnings per Share.” This FSP requires companies to treat unvested share-based payment awards that have non-forfeitable rights to dividends or dividend equivalents as participating securities and thus, include them in calculation of basic earnings per share. FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008. The Company does not anticipate a material impact on its financial statements or its computation of basic earnings per share upon adoption.

During the quarter ended June 30 2008, the Company adopted FSP 00-19-2, Accounting for Registration Payment Arrangements. This FSP specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with FASB Statement No. 5, Accounting for Contingencies. The Company has determined it to be remote, that it will be required to remit payments to the investors for failing to obtain an effective registration statementon or before the required time frame.

2.     Restricted Cash

In July 2007, the Company established a restricted cash balance of 87,500 British pounds, or approximately $157,500 (as of September 30, 2008), as collateral for a deed of guarantee that was required by the English Court of Appeals in order for the Company to pursue an appeal in that court. On March 19, 2008, the Company was notified that its appeal was denied and that the Company owed the European Central Bank, the successful party in the appeal, the 87,500 British pounds. On May 14, 2008, the Company made a payment of 87,500 British pounds to the European Central Bank as an interim payment of the appeal costs pending final assessment by the Court which is expected in the fourth quarter of 2008. The Company was not able to apply the funds in its restricted account to this payment. The Company will use the restricted funds to pay additional fees due upon final assessment of the costs by the Court, if any. Accordingly, the Company classified the restricted cash as current as of September 30, 2008. (See Note 10 Commitments and Contingencies)

3.Inventory

Inventory consisted of the following:

	September 30		December 31,
	2008		2007
	(unaudited)		(audited)
Finished Goods	$	143,606	$	161,978
Raw Materials		86,666		97,464
	$	230,272	$	259,442

8

4.     Other Intangible Assets

Other intangible assets are comprised of the following:

				September 30, 2008						December 31, 2007
	Useful Life			Gross Carrying Amount		Accumulated Amortizaton		Net Carrying Amount		Gross Carrying Amount		Accumulated Amortizaton		Net Carrying Amount
Royalty rights		5 years		$	90,000	$	85,500	$	4,500	$	90,000	$	72,000	$	18,000
Other intangibles		5 years			1,187,595		508,374	$	679,221		1,187,595		335,304		852,291
Patent and contractual rights		Varied	(1)		5,427,570		2,531,006	$	2,896,564		8,205,340		2,926,101		5,279,239
				$	6,705,165	$	3,124,880	$	3,580,285	$	9,482,935	$	3,333,405	$	6,149,530

(1)- patent rights are amortized over their expected useful life which is generally the legal life of the patent. As of September 30, 2008 the weighted average remaining useful life of these assets in service was 3.0 years.

On March 19, 2008, the Company received notification that its appeal of the invalidation of its European Patent 455750B1 in the UK was not successful. As result of the adverse court decision, the Company recognized an impairment loss of approximately $292,000 associated with the U.K appeal as of March 31, 2008. The impairment loss includes a judgment for reimbursement of estimated counterpart legal fees. The Company may owe additional counter party legal fees associated with the decision, which the Company will expense as soon as the amount, if any, is estimatable.

On August 20, 2008, the Company entered into an agreement with Trebuchet Capital Partners, LLC (“Trebuchet”) under which Trebuchet has agreed to pay substantially all of the litigation costs associated with pending validity proceedings initiated by the European Central Bank (“ECB”) in eight European countries relating to the Company’s European Patent 0 455 750B1 that the Company has claimed the ECB infringed in printing of the Euro currency (the “Patent”). Trebuchet also agreed to pay substantially all of the litigation costs associated with future validity challenges filed by the ECB or other parties, provided that Trebuchet elects to assume the defense of any such challenges, in its sole discretion, and patent infringement suits filed against the ECB and certain other alleged infringers of the Patent, all of which suits may be brought at the sole discretion of Trebuchet and may be in the name of the Company, Trebuchet or both. The Company provided Trebuchet with the sole and exclusive right to manage infringement litigation relating to the Patent in Europe, including the right to initiate litigation in the name of the Company, Trebuchet or both and to choose whom and where to sue, subject to certain limitations set forth in the agreement. Under the terms of the Agreement, the Company and Trebuchet have agreed to equally share all proceeds generated from litigation relating to the Patent, including judgments and licenses or other arrangements entered into in settlement of any such litigation. Trebuchet is also entitled to recoup any litigation expenses specifically awarded to the Company in such actions.

Under the terms of the Agreement, and in consideration for Trebuchet’s funding agreement, the Company assigned and transferred a 49% interest of all of the Company’s right, title and interest in the Patent to Trebuchet which allows Trebuchet to have a separate and exclusive interest including a separate and distinct right to exploit the Patent. Pursuant to this transaction, the Company recognized a loss on the sale of patent assets for its assignment and transfer of 49% of its ownership rights in the patent, which had a net book value of approximately $1,670,000, for proceeds of $500,000. As a result, the Company recognized a loss on sale of patent assets of approximately $1,170,000. The Company considered this a triggering event and reviewed its remaining capitalized patent costs for impairment as of September 30, 2008. With the assistance of Trebuchet, the Company determined that the expected eventual outcome of the legal action and recoverability of proceeds or added economic value of the patent was still in excess of the current carrying amount.

9

5.     Revolving Notes

On January 4, 2008, the Company entered into a Credit Facility Agreement with Fagenson and Co., Inc., as agent, a related party to Robert B. Fagenson, the Chairman of the Company's Board of Directors. Under the Fagenson Credit Agreement, the Company can borrow up to a maximum of $3,000,000 from time to time up to and until January 4, 2010. The advances are generally limited to $400,000 unless otherwise mutually agreed upon by both parties per fiscal quarter, with the exception of $600,000 that can be advanced at any time for patent litigation related bills. Any amount borrowed by the Company pursuant to the Fagenson Credit Agreement will have an annual interest rate of 2% above LIBOR and will be secured by the Common Stock of Plastic Printing Professionals, Inc., (“P3”) the Company's wholly owned subsidiary. Interest is payable quarterly in arrears and the principal is payable in full at the end of the term under the Fagenson Credit Agreement. In addition, on January 4, 2008, the Company also entered into a Credit Facility Agreement with Patrick White, the Company's Chief Executive Officer and a member of the Board of Directors. Under the White Credit Agreement, the Company can borrow up to $600,000 from time to time up to and until January 4, 2010. Any amount borrowed by the Company pursuant to the White Credit Agreement will have an annual interest rate of 2% above LIBOR and will be secured by the accounts receivable of the Company, excluding the accounts receivable of P3. Interest is payable quarterly in arrears and the principal is payable in full at the end of the Term under the White Credit Agreement. Mr. White can accept common stock as repayment of the loan upon a default. Under the terms of the agreement the Company is required to comply with various covenants. During the year ended December 31, 2007, Patrick White advanced the Company $300,000 while the terms of the credit facility were being finalized. As of September 30, 2008, the Company was in technical default of both agreements due to a failure to pay interest when due. Both Fagenson and Co., Inc. and Patrick White have agreed to waive the defaults through January 1, 2010.

As of September 30, 2008, the Company had outstanding $450,000 under the White Credit Agreement, $1,408,000 under the Fagenson Credit Agreement. Interest expense amounted to $63,000 for the nine month period ending September 30, 2008 and is included in accrued expenses as of September 30, 2008.

On May 7, 2008 the Company entered into a $500,000 unsecured credit facility with Taiko III Corp to fund the Company’s ongoing patent infringement and related lawsuits against the European Central Bank. Interest shall accrue on the unpaid principal amount at a 6% annual rate. The outstanding principal amount may be prepaid by the Company, in whole but not in part and including the full interest through the maturity of the loan, at its option so long as the Company provides Taiko III with prior written notice of such prepayment. The term of the line of credit is 364 days. In addition, the loan can be repaid by the Company, at the discretion of Taiko III if the Company had defaulted under the credit facility, by using the Company’s common stock at a discount to the market value at the time of the repayment at 33% to market at the time of payment at no less than $2.00 per share and no more than $5.00 per share. On August 20, 2008, the Company entered into an agreement with Trebuchet Capital Partners, which, among other things, called for Trebuchet to pay the Company $500,000, which the Company used to pay in full the Company’s existing obligation owed to Taiko III Corp. See Note 4.

6.     Shareholders’ Equity

Stock Issued for Patent Defense Costs-On November 14, 2006, the Company entered into an stock payment agreement with McDermott Will & Emery LLP (“MWE”), its lead counsel on its European Central Bank (“ECB Litigation”) patent infringement and related cases. The agreement with MWE allows the Company to use its common stock to eliminate the Company’s cash requirements for MWE’s legal fees related to the ECB validity litigation, not to exceed $1.2 million in stock. During the nine months ended September 30, 2007, 60,866 restricted common shares were issued to MWE to pay for approximately $746,000 of legal fees incurred through September 30, 2007.

Stock Issued in Private Placement - On June 25, 2008 the Company entered into two Share Purchase Agreements pursuant to which the Company agreed to sell a total of 500,000 shares of the Company’s common stock for an aggregate purchase price of $2,000,000. Pursuant to the terms of the first Agreement, the Company sold 150,000 shares of Common Stock to the Purchaser for $600,000 payable on June 25, 2008. Pursuant to the terms of the second Agreement, the Company sold 350,000 shares of Common Stock for $1,400,000, with $100,000 payable on June 25, 2008 and the remaining $1,300,000 payable in six-month installments over a two-year period. Pursuant to the terms of the first Agreement, the Purchaser may not sell the 150,000 shares of Common Stock purchased thereunder earlier than June 25, 2009. Pursuant to the terms of the second Agreement, the Purchaser may not sell the 350,000 shares of Common Stock purchased thereunder until the earlier of (i) one year after the Purchase Price being paid in full to the Company, or (ii) the one-year anniversary of a Payment Failure Termination Event (as defined in the second Agreement). (See Note 10 -Commitments)

On January 22, 2007, the Company sold 6 units at a price of $50,000 per unit for gross proceeds of $300,000 consisting of 35,280 unregistered shares of the Company’s common stock and five-year warrants to purchase up to an aggregate of 17,640 shares of the Company’s common stock at an exercise price of $11.75 per share. The fair market value of these warrants was determined using the Black Scholes option pricing model at $107,000.

On August 20, 2008, the Company entered into an agreement with Trebuchet Capital Partners, LLC who agreed to pay substantially all of the litigation costs associated with pending validity proceedings initiated by the ECB in eight European countries relating to the Company’s European Patent 0 455 750B1 that the Company has claimed the ECB infringed in printing of the Euro currency. Trebuchet has also purchased 100,000 shares of the Company’s common stock, for an aggregate purchase price of $400,000, the proceeds of which were used by the Company to pay existing litigation cost.

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Restricted Stock – As of September 30, 2008, there are 42,793 unvested restricted shares granted to employees and consultants that vest through June 2009. In addition, there are 195,000 restricted shares that will vest only upon the occurrence of certain events over the next 4 years, which include, among other things a change of control of the Company or other merger or acquisition of the Company, the achievement of certain financial goals, including among other things a successful result of the Company’s patent infringement lawsuit against the European Central Bank. These 195,000 shares, if vested, would result in the recording of stock based compensation expense of approximately $2,438,000, the grant date fair value, over the period beginning when any of the contingent vesting events is deemed to be probable over the expected requisite service period. As of September 30, 2008, vesting is not considered probable and no compensation expense has been recognized related to the performance grants. On May 10, 2008, the Company accelerated the vesting of 33,333 restricted shares and retired 250,000 of unvested restricted stock as the result of a separation agreement with the Company’s former President. The 33,333 shares of restricted stock, formerly set to vest pro-ratably through June 2009, were accelerated to vest pro-ratably on a monthly basis over a ten-month vesting period ending in March 2009. As a result of the acceleration of the 33,333 shares of restricted stock, the Company recognized approximately $194,000 of stock based compensation during the second quarter of 2008. (See Note 10 -Commitments)

Stock Options– During the nine months ended September 30, 2008, the Company issued options to purchase 37,000 of its common shares at an exercise price of $6.31 per share to non-employee directors pursuant to the 2004 Non-Employee Officer Director Stock Option Plan that vest at the end of one of year of service on the Company’s Board of Directors. The Company also issued options to purchase 50,000 of its common shares at an exercise price of $5.68 per share to employees pursuant to the 2004 Employee Stock Option Plan that will vest over three years. The aggregate fair value of these options amounted to approximately $220,000 determined by utilizing the Black Scholes option pricing model. The Company records stock-based payment expense related to these options based on the grant date fair value in accordance with FASB 123R.

Stock Warrants– During the nine months ended September 30, 2008, the Company received $100,000 in proceeds from the exercise of warrants to purchase 50,000 shares of our common stock. During the nine months ended September 30, 2007, the Company received approximately $55,000 in proceeds from the exercise of warrants to purchase 12,125 shares of our common stock.

Stock-Based Compensation - Stock-based compensation includes expense charges for all stock-based awards to employees, directors and consultants. Such awards include option grants, warrant grants, and restricted stock awards. During the nine months ended September 30, 2008, the Company recognized approximately $1,536,000 ($971,000- 2007) in stock-based compensation. Approximately $194,000 of the expense was the result of the acceleration of vesting of restricted shares to the Company’s former President as the result of his separation from the Company in May 2008.

As of September 30, 2008, there was approximately $816,000 of total unrecognized compensation costs related to non-vested options and restricted stock granted under the Company’s stock option plans which the Company expects to vest over a period of not to exceed five years.

On August 13, 2008, the Company cancelled 330,500 employee stock options with exercise prices ranging from $6.24 to $12.50, and replaced the cancelled options with 330,500 employee stock options with an exercise price of $6.00. No other terms of the options were modified. On the date of grant, the fair market value of the Company’s Common Stock was $5.15. The repricing was treated as a modification under FAS123R, and resulted in an additional aggregate fair value expense determined using the Black- Scholes option pricing model of approximately $225,000, of which approximately $170,000 was expensed as of the grant date for fully vested options. The remaining fair value of the modified options will be expensed proratably during the expected vesting period of the options thru 2010.

7.   Other Income

On May 31, 2008, the Company was awarded a judgment of approximately $126,000 pursuant to a positive judgement for the Company in its counterclaim the matter “Frank LaLoggia v. Document Security Systems, Inc”, which the Company won in June 2006. The Company expects to collect the full amount of the judgment.

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8.     Discontinued Operations

On September 25, 2007, the Company sold certain assets and the operations of its retail copying and quickprinting operations to an unrelated third party for $80,000 and the assumption of ongoing operating leases. The sale included fixed assets with a net book value of approximately $37,000. The Company recognized a gain on the sale of approximately $43,000. In accordance with SFAS 144, the disposal of assets constitutes a component of the entity and has been accounted for as discontinued operations. The operating results relating to these assets are segregated and reported as discontinued operations in the accompanying 2007 consolidated statement of operations. The results of operations directly attributed to the division’s operations that have been reclassified from continuing operations are as follows:

	Three Months Ended			Nine Months Ended
	September 30, 2007			September 30, 2007
Revenues	$	72,791			292,282
Cost of sales		48,720			150,525
Operating expenses		67,878			200,990
Income from discontinued operations	$	(43,807	)		(59,233	)

9.     Earnings Per Share

Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted earnings per share is computed by including the number of additional shares that would have been outstanding if dilutive potential shares had been issued. In periods of losses, diluted loss per share is computed on the same basis as basic loss per share as the inclusion of any other potential shares outstanding would be anti-dilutive.  If the Company had generated earnings during the nine month period ended September 30, 2008, 426,980 (767,887- 2007) common equivalent shares would have been added to the weighted average shares outstanding to compute the diluted weighted average shares outstanding.

10.     Commitments and Contingencies

Legal Matters

On August 1, 2005, the Company commenced a suit against the European Central Bank (“ECB”) alleging patent infringement by the ECB and claimed unspecified damages. The suit was brought in European Court of First Instance in Luxembourg. The Company alleged that all Euro banknotes in circulation infringe the Company European Patent 0 455 750B1 (the “Patent”), which covers a method of incorporating an anti-counterfeiting feature into banknotes or similar security documents to protect against forgeries by digital scanning and copying devices. The Court of First Instance ruled on September 5, 2007 that it does not have jurisdiction to rule on the patent infringement claim, and also ruled that the Company will be required to pay attorneys and court fees of the ECB. The ECB formally requested the Company to pay attorneys and court fees in the amount of Euro 93,752 ($144,000), which, unless the amount is agreed will be subject to an assessment procedure that will not likely be concluded until approximately the end of 2008, which the Company will accrue as soon as the assessed amount, if any, is estimatable.

On March 24, 2006, the Company received notice that the ECB has filed a separate claim in the United Kingdom and Luxembourg courts seeking the invalidation of the Patent. Proceedings were commenced before the national courts seeking revocation and declarations ofinvalidityof the Patent in each of the Netherlands, Belgium, Italy, France, Spain, Germany and Austria. On March 26, 2007, the High Court of Justice, Chancery Division, Patents Court in London, England (the “English Court”) ruled that the Patent was deemed invalid in the United Kingdom, and on March 19, 2008 this decision was upheld on appeal. The English Court rejected the ECB’s allegations of invalidity based on lack of novelty, lack of inventive step and insufficiency, but held that the patent was invalid for added subject matter. The English Court’s decision does not affect the validity of the Patent in other European countries. On March 30, 2007, the English Court awarded the ECB 30% of their costs (including legal fees) of the initial trial, of which the Company paid 90,000 British pounds ($182,000) on April 19, 2007. We expect that an additional 90,000 pounds ($162,000 at September 30, 2008) will become payable by the Company for the costs of the initial trial, which is included in accrued expenses as of September 30, 2008. In July 2007, the Company posted a bond of 87,500 British pounds ($157,500 at September 30, 2008), as collateral for the appeal costs which is recorded as restricted cash at September 30, 2008. On June 19, 2008, the Company paid 87,500 British pounds ($177,000 based on the applicable exchange rate on that date) towards theECB’s costs of the English appeal. The Company may also owe additional legal fees associated with the Court of Appeal decisions, which, unless otherwise agreed by the parties, will be subject to an assessment procedure that will not likely be concluded earlier than the first quarter of 2009. The Company will record the assessed amount, if any, as soon as it is estimatable.

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On March 27, 2007 the Bundespatentgericht of the Federal Republic of Germany ruled that the German part of the Patent was valid, having considered the English Court’s decision. As a result of this ruling, the Company expects to be awarded reimbursements for its costs associated with the German validity case, which is Euro 44,692 ($64,000 at September 30, 2008), which the Company will record when the amount, if any, is received. The ECB has filed an appeal against that decision, which is not expected to be decided before 2010. On January 9, 2008 the French Court held that the Patent was invalid in France for the same reasons given by the English Court. The Company is required to pay de minimus attorneys’ fees of the ECB as a result of the French decision. The Company filed an appeal against the French decision on May 7, 2008. On March 12, 2008 the Dutch Court, having considered the English, German and French decisions, ruled that the Patent is valid in the Netherlands. The ECB filed an appeal against the Dutch decision on March 27, 2008. A trial was also held in Madrid, Spain on June 3 and 5, 2008 and oral and written closing submissions were made on July 19, 2008. A judgment is expected in the fourth quarter of 2008.

The Patent has thus been confirmed to be valid and enforceable in two jurisdictions (Germany and the Netherlands) that use the Euro as its national currency. Additional trials on the validity of the Patent are expected in other European jurisdictions in 2008 and 2009.

On August 20, 2008, the Company entered into an agreement with Trebuchet Capital Partners, LLC (“Trebuchet”) under which Trebuchet has agreed to pay substantially all of the litigation costs associated with pending validity proceedings initiated by the European Central Bank (“ECB”) in eight European countries relating to the Company’s European Patent 0 455 750B1 that the Company has claimed the ECB infringed in printing of the Euro currency (the “Patent”). Trebuchet also agreed to pay substantially all of the litigation costs associated with future validity challenges filed by the ECB or other parties, provided that Trebuchet elects to assume the defense of any such challenges, in its sole discretion, and patent infringement suits filed against the ECB and certain other alleged infringers of the Patent, all of which suits may be brought at the sole discretion of Trebuchet and may be in the name of the Company, Trebuchet or both. The Company provided Trebuchet with the sole and exclusive right to manage infringement litigation relating to the Patent in Europe, including the right to initiate litigation in the name of the Company, Trebuchet or both and to choose whom and where to sue, subject to certain limitations set forth in the agreement. Under the terms of the Agreement, the Company and Trebuchet have agreed to equally share all proceeds generated from litigation relating to the Patent, including judgments and licenses or other arrangements entered into in settlement of any such litigation. Trebuchet is also entitled to recoup any litigation expenses specifically awarded to the Company in such actions.

On January 31, 2003, the Company commenced an action, unrelated to the above ECB litigation, entitled New Sky Communications, Inc., As Successor-In-Interest To Thomas M. Wicker, Thomas M.Wicker Enterprises, Inc. and Document Security Consultants V. Adler Technologies, Inc. N/K/A Adlertech International, Inc. and Andrew McTaggert (United States District Court, Western District Of New York Case No.03-Cv-6044t(F)) regarding certain intellectual property in which the Company has an interest. The Company commenced this action alleging various causes of action against Adler Technologies, Inc. and Andrew McTaggert for breach of contract, breach of the duty of good faith and fair dealing, various business torts, including unfair competition and declaratory relief. Adler distributes and supplies anti-counterfeit document products and Mr. McTaggert is a principal of Adler. Adler had entered into several purported agreements with Thomas M. Wicker Enterprises and Document Security Consultants, both of which the Company acquired in 2002. These alleged agreements, generally, would have authorized Adler to manufacture in Canada the Company’s “Checkmate®” patented system for verifying the authenticity of currency and documents. Other purported agreements were signed between these parties and Thomas Wicker regarding other technology claimed to have been owned by Wicker and assigned to the Company. Among other things, the Company contends that certain of the purported agreements are not binding and/or enforceable. To the extent any of them are binding and enforceable, the Company claims that Adler has breached these purported agreements, failed to make an appropriate accounting and payments under them, and may have exceeded the scope of its license. Adler has denied the material allegations of the complaint and has counterclaimed against the Company, claiming Adler owns or co-owns or has a license to use certain of the Company’s technologies. In May 2005, the Company filed a first amended and supplemental complaint adding Blanks/USA and Raymond Maxon as additional defendants. In February 2007, the Company filed a second amended and supplemental complaint adding Judith Wu (McTaggert’s wife) and Arcis Digital Security, Inc. (a company in which Ms. Wu is involved) as additional defendants. Maxon has asserted a counterclaim against the Company contending that the Company’s purported acquisition of a certain patent from Thomas Wicker in 2002 gave rise to an alleged right on the part of Maxon to receive a portion of Thomas Wicker’s proceeds from such acquisition. The Company has denied the material allegations of all of the counterclaims. If Adler or Maxon is successful, it may materially affect the Company, the Company’s financial condition, and the Company’s ability to market and sell certain of the Company technology and related products. This case is in discovery phase, and it is too soon to determine how the various issues raised by the lawsuit will be determined.

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In addition to the foregoing, the Company is subject to other legal proceedings that have arisen in the ordinary course of business and have not been finally adjudicated. Although there can be no assurance in this regard, in the opinion of management, none of these legal proceedings to which the Company is a party to will have a material adverse effect on the Company results of operations, cash flows or the Company’s financial condition.

Commitments

In May 2008, the Company entered into a Separation Agreement with its former President that, among other things, accelerated the vesting of 33,333 shares of restricted common stock of the Company that were previously awarded to the former President pursuant to the Company’s 2004 Employee Stock Option Plan so that such shares vested in equal monthly installments during the immediately following ten months. The Separation Agreement further provided that if the former President did not realize at least $212,000 in gross proceeds from the sale of such 33,333 shares of restricted stock upon their vesting, then the Company would pay the former President the amount that such proceeds is less than $212,000 in cash or additional shares of common stock of the Company. As of September 30, 2008, 13,333 of such 33,333 shares had vested generating gross proceeds of approximately $48,000.

In June 2008, the Company entered into two Stock Purchase Agreements in which it sold 500,000 shares of its common stock to Walton Invesco Inc. for an aggregate purchase price of $2.0 million. Pursuant to the terms of such Stock Purchase Agreements, Walton Invesco Inc. may demand registration of such 500,000 shares with the Securities and Exchange Commission on Form S-3 with such registration statement to take effect no later than (i) 120 days after payment in full for such shares under the applicable agreement or, (ii) with respect to 350,000 shares, 270 days after a Payment Failure Termination Event (as defined in the applicable Stock Purchase Agreement).

Pursuant to an agreement made in December 2004, the Company is required to share the economic benefit derived from settlements, licenses or subsequent business arrangements that the Company obtains from any infringer of patents formerly owned by the Wicker Family. For infringement matters involving certain U.S. patents, the Company will be required to disburse 30% of the settlement proceeds. For infringement matters involving certain foreign patents, including the lawsuit against the European Central Bank described in Part II Item 1 – Legal Proceedings, the Company will be required to disburse 14% of the settlement proceeds. These payments do not apply to licenses or royalties to patents that the Company has developed or obtained from persons other than the Wicker Family. As of September 30, 2008, there have been no settlement amounts related to these agreements.

In May 2005, the Company made an agreement with its legal counsel in charge of the Company’s patent infringement litigation in the Court of First Instance with the European Central Bank which capped its fees for all matters associated with that infringement litigation at $500,000 plus expenses, and a $150,000 contingent payment upon a successful ruling or settlement on the Company’s behalf in that litigation. The Company will record the $150,000 in the period in which the Company has determined that a successful ruling or settlement is probable.

11   Supplemental Cash Flow Information

During the nine months ended September 30, 2008, the Company issued 19,260 shares for the payment of approximately $94,000 of marketing expenses. During the nine months ended September 30, 2007, the Company issued 60,866 shares of Common Stock valued at approximately $746,000 in conjunction with the payment of legal expenses which were capitalized as other intangible assets. In addition, the Company extended the term of previously issued warrants to a warrant holder in exchange for a license valued at approximately $521,000. In addition, during 2007, the Company issued fully vested, nonforfeitable warrants to consultants of approximately $525,000 that were recorded as a prepaid expense that was recognized as stock based compensation. As of September 30, 2008, all of this amount had been recognized as expense.

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12.     Segment Information

The Company's businesses are organized, managed and internally reported as three operating segments. Two of these operating segments, Document Security Systems and Plastic Printing Professionals, are engaged in various aspects of developing and applying printing technologies and procedures to produce, or allow others to produce, documents with a wide range of features, including the Company’s patented technologies and trade secrets. For the purposes of providing segment information, these two operating segments have been aggregated into one reportable segment in accordance with Financial Accounting Standards Board (“FASB”) Statement No. 131- “Disclosures about Segments of an Enterprise and Related Information”. A summary of the Company’s two segments is as follows:

Document Security and Production

License, manufacture and sale of document security technologies, including digital security print solutions and secure printed products at Document Security Systems and Plastic Printing Professionals divisions. In September 2007, the Company sold substantially all of the assets of its retail printing and copying division, a former component of the Document Security and Production segment, to an unrelated third party as this operation was not critical to the Company’s core operations. The results of the retail and copying division are reported as discontinued operations and are not a component of these segment results (See Note 8).

Legal Supplies

Sale of specialty legal supplies, primarily to lawyers and law firms located throughout the United States via the website Legalstore.com.

            Approximate information concerning the operations by reportable segment for the three and nine months ended September 30, 2008 and 2007 is as follows. The Company relies on intersegment cooperation and management does not represent that these segments, if operated independently, would report the results contained herein:

				Document
				Security &
	Legal Supplies			Production			Corporate			Total
3 months ended September 30, 2008:
Revenues from external customers	$	151,000		$	1,523,000		$	-		$	1,674,000
Depreciation and amortization		4,000			615,000			1,000			620,000
Segment profit (loss) from continuing operations		(6,000	)		(2,046,000	)		(611,000	)		(2,663,000	)
Identifiable assets		328,000			7,479,000			548,000			8,355,000
3 months ended September 30, 2007:
Revenues from external customers	$	176,000		$	1,233,000		$	-		$	1,409,000
Depreciation and amortization		4,000			521,000			1,000			526,000
Segment profit (loss) from continuing operations		(13,000	)		(799,000	)		(1,069,000	)		(1,881,000	)
Identifiable assets		255,000			10,564,000			1,562,000			12,381,000

				Document
				Security &
	Legal Supplies			Production			Corporate			Total
9 months ended September 30, 2008:
Revenues from external customers	$	483,000		$	4,847,000		$	-		$	5,330,000
Depreciation and amortization		12,000			1,827,000			3,000			1,842,000
Segment profit (loss) from continuing operations		29,000			(4,293,000	)		(1,918,000	)		(6,182,000	)
Identifiable assets		328,000			7,479,000			548,000			8,355,000
9 months ended September 30, 2007:
Revenues from external customers	$	513,000		$	3,820,000		$	-		$	4,333,000
Depreciation and amortization		10,000			1,356,000			30,000			1,396,000
Segment profit (loss) from continuing operations		(11,000	)		(2,217,000	)		(2,547,000	)		(4,775,000	)
Identifiable assets		255,000			10,564,000			1,562,000			12,381,000

13.     Subsequent Events

On November 6, 2008 the Company entered into an asset purchase agreement to acquire the assets of DPI of Rochester, LLC (“DPI”), which agreement is subject to court approval in DPI’s pending Chapter 11 bankruptcy case. DPI is a full service digital and commercial offset printer located in Rochester, NY with approximately $7.6 Million in annual sales in 2007. The estimated purchase price is $1,000,000 plus the assumption of certain equipment leases, and the Company may provide debtor-in-possession financing, subject to United States Bankruptcy Court approval, to DPI during its Chapter 11 reorganization process to prevent any disruption of service to DPI’s customers. The purchase of assets is expected to be completed in the quarter ended December 31, 2008 and is subject to the United States Bankruptcy Court approval and an opportunity for other parties to overbid for DPI’s assets. The obligations under the agreement are conditioned upon the negotiation of real and personal property leases, the approval of the bankruptcy court and other matters. There can be no assurance that the transaction contemplated by the purchase agreement will be approved by the bankruptcy court or that the conditions to closing will be met. Upon court approval of the transaction, the purchase price, once known, will be allocated to the assets acquired based on their respective fair values.

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ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

Certain statements contained herein constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “1995 Reform Act”). Document Security Systems, Inc. desires to avail itself of certain “safe harbor” provisions of the 1995 Reform Act and is therefore including this special note to enable us to do so. Except for the historical information contained herein, this report contains forward-looking statements (identified by the words "estimate," "project," "anticipate," "plan," "expect," "intend," "believe," "hope," "strategy" and similar expressions), which are based on our current expectations and speak only as of the date made. These forward-looking statements are subject to various risks, uncertainties and factors, including, without limitation, those contained in our Form 10-K for the year ended December 31, 2007 and those described herein that could cause actual results to differ materially from the results anticipated in the forward-looking statements.

Overview

Document Security Systems, Inc. (referred to in this report as “Document Security,” “we,” “us,” “our” or “Company”) markets and sells products designed to protect valuable information from unauthorized scanning, copying, and digital imaging. We develop sophisticated security technologies that are applied during the normal printing process and by virtually all printing methods including traditional offset, gravure, flexo, digital or via the Internet on paper, plastic, or packaging. We believe we are a leader of customized document protection solutions for companies and governments worldwide. We hold eight patents that protect our technology and have over a dozen patents in process or pending. Our technologies and products are used by federal, state and local governments, law enforcement agencies and are also applied by a broad variety of industries,, including financial institutions, high technology and consumer goods, entertainment and gaming, healthcare/pharmaceutical, defense and genuine parts industries.Our customers use our technologies where there is a need for enhanced security for protecting and verification of critical financial instruments and vital records, or where there are concerns of counterfeiting, fraud, identity theft, brand protection and liability.

Our core business is counterfeit prevention, brand protection and validation of authentic print media, including government-issued documents, currency, private corporate record and, securities. We believe we are a world leader in the research and development of optical deterrent technologies and have commercialized these technologies with a broad suite of products that offer our customers a wide array of document security solutions to satisfy their specific anti-counterfeiting requirements. Our technology can be used in securing sensitive and critical documents such as currency, automobile titles, spare parts forms for the aerospace industry, gift certificates, permits, checks, licenses, receipts, prescription and medical forms, engineering schematics, ID cards, labels, original music, coupons, homeland security manuals, consumer product and pharmaceutical packaging, tickets, and school transcripts. In addition, we have developed a digital product to implement our technologies in Internet-based environments utilizing standard desktop printers. We believe that our digital technology greatly expands the reach and potential market for our technologies and solutions.

Technologies

We have developed or acquired over 30 technologies that provide to our customers a wide spectrum of solutions. Our primary anti-counterfeiting products and technologies are marketed under the AuthentiGuard trade names.

Products and Services

Document Security Solutions and Production: Our technology portfolio allows us to create unique custom secure paper, plastic, packaging and Internet-based solutions. We market to end-users that require anti-counterfeiting and authentication features in a wide range of printed materials like documents, vital records, driver’s licenses, birth certificates, receipts, manuals, identification materials, entertainment tickets, coupons, parts tracking forms, as well as product packaging including pharmaceutical and a wide range of consumer goods. We manufacture plastic ID cards at our wholly owned subsidiary called Plastic Printing Professionals, in San Francisco, CA, and we produce our custom security paper products either internally at our small printing facility in Rochester, NY, or outsourced at our various licensees. Through our strategic licensee program, we can offer our customers a wide range of production capabilities to meet the customized requirements.

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Security Paper: Our primary product for the retail end-user market is AuthentiGuard Security Paper. AuthentiGuard Security Paper uses our Pantograph 4000 technology, and is a paper that reveals hidden warning words, logos or images using The Authenticator - our proprietary viewing lens – or when the paper is faxed, copied, scanned or re-imaged. The hidden warning words appear on the duplicate or the computer digital file and essentially prevents important documents from being counterfeited. We market and sell our Security Paper primarily through two major paper distributors: Boise Cascade and PaperlinX Limited.

Technology Licensing: We license our anti-counterfeiting technology and trade secrets through licensing arrangements with security printers. We seek licensees that have a broad customer base that can benefit from our technologies or have unique and strategic capabilities that expand the capabilities that we can offer our potential customers. Revenue from licensing can take several forms. Licenses can be for a single technology or for a package of technologies.  

Digital Solutions:We also offer our technologies in digital forms that are deliverable via internet and intranet environments. In October 2008, we launched our first branded digital solution called AuthentiGuard® DX. AuthentiGuard® DX is a networked appliance that allows the author of any Microsoft Office document (Outlook, Word, Excel, or PowerPoint) to secure nearly any of its alphanumeric content when it is printed or digitally stored. AuthentiGuard® DX prints selected content using our patented technology so that it cannot be read by the naked eye. Reading the hidden content or authenticating the document is performed with a proprietary viewing device or software.

Additionally, we sell custom hosted or server-based digital solutions for our customers. Depending on our customer’s specific requirements, we host a secure server that accepts user inputs and delivers custom, variable secure documents for output at the user location, or offer a bundled server solution that allows for the production of custom, variable secure documents within the user’s network environment.

Legal Products: We also own and operate Legalstore.com, an Internet company which sells legal supplies and documents, including security paper and products for the users of legal documents and supplies in the legal, medical and educational fields. While not a component of our core business strategy, we continuously seek to maximize the revenue and profitability of this operation.

Results of Operations for the Three and Nine Months EndedSeptember 30, 2008

The following discussion and analysis provides information that our management believes is relevant to an assessment and understanding of our results of operations and financial condition. The discussion should be read in conjunction with the financial statements and footnotes in this quarterly report and in our annual report on Form 10-K for the year ended December 31, 2007. On September 25, 2007, the Company sold its copying and quick-printing business to an unrelated third party. In accordance with FASB 144, the Company accounts for the revenue and expenses of this operation, which was a component of its security printing segment, as a discontinued operation. All amounts have been adjusted to reflect the Company’s results after the effect of discontinued operations.

Revenue

	Three Months  Ended September 30, 2008		Three Months  Ended September 30, 2007		% change vs. 2007			Nine Months  Ended September 30, 2008		Nine Months  Ended September 30, 2007		% change vs. 2007
Revenue
Security printing & products	$	1,334,000	$	946,000		41	%	$	3,421,000	$	2,765,000		24	%
Royalties		181,000		278,000		-35	%		1,402,000		871,000		61	%
Digital solutions		8,000		9,000		-11	%		25,000		184,000		-86	%
Legal products		150,000		176,000		-15	%		483,000		513,000		-6	%
Total Revenue		1,673,000		1,409,000		19	%		5,331,000		4,333,000		23	%

For the three months ended September 30, 2008, revenue increased 19% from the same period in 2007. The increase in revenue was primarily the result of strong growth in sales of our security products. The Company has sought to become a full-service provider of printing and production for its customers. During the quarter, the Company saw 20% sales growth at its Plastic Printing division as that division began to see the benefit of recent capital investments that increased its production capacity and expanded its production capabilities. Sales for paper based security products grew 30% from the same quarter of 2007, as the Company benefited from increased sales of its safety paper for prescriptions, and custom projects, including voter registration paper used for a foreign election, and coupons for a Fortune 500 customer.

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Royalty revenue decreased primarily due to the absence of royalty revenue as a result of the new agreement with the Ergonomics Group in the second quarter of 2008, as described below, which previously had contributed approximately $60,000 per quarter of royalty revenue. Otherwise, royalty revenue reflected reductions in technology usage reported by its remaining licensing customers.

Legalstore.com saw an approximately 15% decline in orders from the 2007 quarter, which we believe was due to slowing conditions in the general economy along with the effects of an issue with its adword placements on one of the major search engine sites. The Company addressed its adword issue at the end of the quarter, and expects legal products to return to historical levels in the fourth quarter of 2008.

For the first nine months of 2008, revenue increased 23% compared to the first nine months of 2007 primarily as a the result of the significant impact of royalty revenue recognized in the second quarter of 2008 along with a 24% growth in the company’s sales of its security printing and products. During the second quarter of 2008, the Company recognized approximately $542,000 of previously deferred royalty revenue as the result of a new agreement with the Ergonomic Group in April 2008. Under a previous agreement with the Ergonomic Group, the Company received $1,000,000 in non-refundable license and royalty fees, of which $500,000 was recognized as royalty revenue pro-ratably over a two year license period and the remaining $500,000 was considered a prepaid royalty, to be recognized as revenue when sales of products using the licensed technology were made. This agreement was cancelled and a new agreement with the Ergonomic Group that covers the Company’s newest digital technologies was established. As a result, the non refundable license and royalty payment no longer met the criteria for deferral and was recognized in the second quarter of 2008.

These growth areas were partially offset by a significant decline in digital solutions sales during the first nine months of 2008 as compared to the first nine months of 2007 due to the absence of any digital solutions implementations during 2008.

Cost of Sales and Gross Profit

	Three Months  Ended September 30, 2008		Three Months  Ended September 30, 2007		% change vs. 2007			Nine Months  Ended September 30, 2008		Nine Months  Ended September 30, 2007		% change vs. 2007
Costs of revenue
Security printing & products	$	636,000	$	636,000		0	%	$	2,028,000	$	1,691,000		20	%
Digital solutions		4,000		3,000		33	%		11,000		41,000		-73	%
Legal products		86,000		83,000		4	%		258,000		276,000		-7	%
Total cost of revenue		726,000		722,000		1	%		2,297,000		2,008,000		14	%
Gross profit
Security printing & products		698,000		310,000		125	%		1,393,000		1,074,000		30	%
Royalties		181,000		278,000		-35	%		1,402,000		871,000		61	%
Digital solutions		4,000		6,000		-33	%		14,000		143,000		-90	%
Legal products		64,000		93,000		-31	%		225,000		237,000		-5	%
Total gross profit		947,000		687,000		38	%		3,034,000		2,325,000		30	%

	Three Months  Ended September 30, 2008			Three Months  Ended September 30, 2007			% change vs. 2007			Nine Months  Ended September 30, 2008			Nine Months  Ended September 30, 2007			% change vs. 2007
Gross profit percentage:
Gross profit percentage:		57	%		49	%		16	%		57	%		54	%		6	%

Gross profit increased 38% to $947,000 in the thrid quarter of 2008 as compared to the $687,000 of gross profit realized in the third quarter of 2007, primarily the result of stong sales of the company’s security printing and products and the ability of the Company to increase its margins through operating efficiencies and material cost savings that the Company was able to generate at its plastics division’s new facility. The increase in gross profits of this group was partially offset by decreases in royalty, digital solution and legal products profits, respectively, for reasons discussed above. For the nine months ended September 30, 2008, the Company’s gross profit increased at a slightly higher rate as the Company’s gross profit percentage increased 6 percentage points as compared to the 2007 period.

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Operating Expenses

	Three Months  Ended September 30, 2008		Three Months  Ended September 30, 2007		% change vs. 2007			Nine Months  Ended September 30, 2008		Nine Months  Ended September 30, 2007		% change vs. 2007
Selling, general and administrative
General and administrative compensation	$	539,000	$	514,000		5	%	$	1,622,000	$	1,310,000		24	%
Professional Fees		206,000		352,000		-41	%		780,000		1,036,000		-25	%
Sales and marketing		204,000		466,000		-56	%		892,000		1,525,000		-42	%
Depreciation and amortization		42,000		20,000		110	%		126,000		61,000		107	%
Other		319,000		289,000		10	%		902,000		685,000		32	%
Research and development		73,000		111,000		-34	%		322,000		314,000		3	%
Stock based payments		480,000		338,000		42	%		1,506,000		971,000		55	%
Impairment of patent defense costs		-		-					292,000		-
Amortization of intangibles		541,000		480,000		13	%		1,605,000		1,259,000		27	%
Total Operating Expenses		2,404,000		2,570,000		-6	%		8,047,000		7,161,000		12	%

Selling, General and Administrative 

General and administrative compensation costs were 5% higher in the third quarter of 2008 as compared to the third quarter of 2007 which was primarily due to the impact of a bonus reversal of approximately $41,000 in the 2007 period, which offset the impact of salary reductions made by the Company during 2008. In addition, the 2008 amount reflects an increase in the cash compensation of the non-employee members of the Company’s board of directors.

Professional fees - The decrease in professional fees during the third quarter and first nine months of 2008 reflect significant decreases in non-patent related legal fees, accounting fees, and stock transfer and investor relations fees. These costs savings reflect reduced SEC compliance costs and decreased legal activity, along with the impact of the Company’s cost-cutting program it initiated in March 2008. For the nine months ended September 30, 2008, these cost savings were partially offset by increases in the use of consultants for sales and business development efforts during the first three months of 2008.

	Three Months  Ended September 30, 2008		Three Months  Ended September 30, 2007		% change vs. 2007			Nine Months  Ended September 30, 2008		Nine Months  Ended September 30, 2007		% change vs. 2007
Professional Fees Detail
Accounting and auditing	$	40,000	$	71,000		-44	%	$	213,000	$	236,000		-10	%
Consulting		79,000		95,000		-17	%	$	341,000		292,000		17	%
Legal Fees		43,000		120,000		-64	%	$	94,000		255,000		-63	%
Stock Transfer, SEC and Investor Relations		44,000		66,000		-33	%	$	132,000		253,000		-48	%
	$	206,000	$	352,000		-41	%	$	780,000	$	1,036,000		-25	%

Sales and marketing expenses, including sales and marketing personnel costs, decreased in the third quarter and the first nine months of 2008 as the Company reduced sales and marketing headcount by four, reduced public relations and marketing costs and significantly reduced the amount spent on travel and entertainment. The Company reduced these costs as it realigned its sales process in order to maximize the results of its sales and marketing efforts with the goal of focusing of near term revenue opportunities.

Other operating expenses are primarily rent and utilities, office supplies, IT support, bad debt expense and insurance costs. Increases in the third quarter an first nine months of 2008 reflect costs increases associated with an increase in rent costs and one time costs associated with the move of the Company’s plastic printing division to a larger facility, higher utility costs, and an increase in insurance costs.

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Stock-Based Compensation. Stock-based compensation includes expense charges for all stock-based awards to employees, directors and consultants. Such awards include option grants, warrant grants, and restricted stock awards. Stock-based compensation increases in the three and nine month periods ended September 30, 2008 reflect equity-based payments made to employees, directors, and third-party consultants, including approximately $194,000 of expense as the result of the acceleration of vesting of restricted shares and $18,000 due to the modification of options to the Company’s former President as the result of his separation from the Company in May 2008. In addition, on August 13, 2008, the Company cancelled 330,500 employee stock options with exercise prices ranging from $6.24 to $12.50, and replaced the cancelled options with 330,500 employee stock options with an exercise price of $6.00. No other terms of the options were modified. On the date of grant, the fair market value of the Company’s Common Stock was $5.15. The repricing was treated as a modification under FAS123R, and resulted additional aggregate fair value expense determined using the Black- Scholes option pricing model of approximately $225,000, of which approximately $170,000 was expensed as of the grant date for fully vested options. The remaining fair value of the modified options will be expense proratably during the expected vesting period of the options thru 2010.

Research and Development

We invest in research and development to improve our existing technologies and develop new technologies that will enhance our position in the document security market. Research and development costs consist primarily of compensation costs, and costs for the use of third-party printers’ facilities to test our technologies on equipment that we do not have access to internally. During the third quarter of 2008, the Company reduced its research and development by one person who was replaced on October 1, 2008.

Impairment of Patent Defense Costs

On March 19, 2008, the Company received notification that its appeal of the invalidation of its European Patent 455750B1 in the UK was not successful. As result of the adverse court decision, the Company recognized an impairment loss of $292,000 associated with the U.K appeal as of March 31, 2008. The impairment loss includes a judgment for reimbursement of estimated counterpart legal fees. The Company may be obligated to pay additional counter party legal fees associated with the decision, which the Company will expense as soon as the amount, if any, is estimatable.

Amortization of Intangibles

Amortization of intangibles expense increased 13% in the third quarter of 2008 as compared to the third quarter of 2007 which was primarily the result of an increase of $1.1 million in the Company’s capitalized patent defense costs from December 2007 to September 2008. We amortize the costs associated with patent rights that we acquired in 2005 and legal costs associated with the registration and defense of our patents, including the costs associated with our lawsuit against the ECB for patent infringement and the related ECB countersuits for patent validity. A significant portion of these assets were acquired by the issuance of equity-based instruments. On August 20, 2008, the Company entered into an agreement with Trebuchet Capital Partners which agreed to pay substantially all of the litigation costs associated with its ECB litigation. Under the terms of the agreement the Company transferred and assigned a 49% interest of all of the Company’s rights, title and interest in its European Patent 0455750B1 and the two parties agreed to equally share all proceeds generated from litigation relating to the Patent, including judgments and licenses or other arrangements entered into in settlement of any such litigation. The Company considered this a triggering event and reviewed its remaining capitalized patent costs related to the Patent for impairment as of September 30, 2008. With the assistance of Trebuchet, the Company determined that the expected eventual outcome of the legal action and recoverability of proceeds or added economic value of the patent was still in excess of the current carrying amount.

As a result of the Trebuchet agreement, and the transfer and assignment of our 49% interest in the patent, or $1,670,000, our net amortizable patent asset base at September 30, 2008 was approximately $2.9 million and will generate approximately $1.0 million in annual amortization expense during the next 3 years, as compared to approximately $2.0 million in annual amortization expense the Company was recognizing prior to the Trebuchet transaction.

In addition, the Company has approximately $683,000 of net other intangible assets as of September 30, 2008 that consist of a royalty right, a non-exclusive marketing right, as well as acquired intangibles including customer lists and a trade name. These assets will generate approximately $250,000 of annual amortization expense during the next 2.5 years. In addition, the Company has approximately $1,397,000 in goodwill derived from acquisitions. Goodwill is not amortized, but could become a component of expense if an impairment is determined. The Company reviews these assets for impairment annually or if a triggering event occurs. If an impairment, such as unfavorable ruling in the Company’s patent validity or infringement lawsuits or an assessment of non-commerciability of certain of its patents, then the Company would write-off a portion of these assets, which could be a significant expense in the period incurred.

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Other Income and Expense

On May 31, 2008, the Company was awarded a judgment of approximately $126,000 pursuant to a counterclaim by the Company in the matter “Frank LaLoggia v. Document Security Systems, Inc”, which the Company won in June 2006. The Company expects to collect the full amount of the judgment.

On August 20, 2008, the Company entered into an agreement with Trebuchet Capital Partners, LLC. Pursuant to the Agreement, Trebuchet has agreed to pay substantially all of the litigation costs associated with pending validity proceedings initiated by the European Central Bank in eight European countries relating to the Company’s European Patent 0 455 750B1 that the Company has claimed the European Central Bank ("ECB") infringed in printing of the Euros currency. Under the terms of the Agreement, and in consideration for Trebuchet’s funding obligations, the Company assigned and transferred a 49% interest of the Company’s rights, title and interest in the Patent to Trebuchet which allows Trebuchet to have as a separate and exclusive interest including a separate and distinct right to exploit the Patent. Pursuant to this transaction, the Company recognized a loss on the sale of patent assets for its assignment and transfer of 49% of its ownership rights in the patent, which had a net book value of approximately $1,670,000, for proceeds of $500,000, As a result, the Company recognized a loss on sale of patent assets of approximately $1,170,000.

Net Loss and Loss Per Share

	Three Months  Ended September 30, 2008			Three Months  Ended September 30, 2007			% change vs. 2007			Nine Months  Ended September 30, 2008			Nine Months  Ended September 30, 2007			% change vs. 2007
Net loss		(2,664,000	)		(1,881,000	)		42	%		(6,182,000	)		(4,792,000	)		29	%
Net loss per share, basic and diluted	$	(0.19	)	$	(0.14	)		36	%	$	(0.45	)	$	(0.35	)		29	%
Weighted average common shares outstanding, basic and diluted		14,286,192			13,676,030			4	%		13,879,891			13,629,241			2	%

During the third quarter of 2008, the Company experienced a net loss of $2.7 million, a 42% increase from the net loss of the third quarter of 2007. The increase in net loss during the quarter was primarily the result of the Company’s recognition of a one-time loss on the sale of patent assets of $1.2 million. Otherwise, net loss for the third quarter of 2008 quarter without the impact of this one time loss would have been approximately $1.5 million, a decrease of approximately 20% from the third quarter of 2007. The improvement in net loss, other than the effect of the one-time loss on sale of patent, was due the Company’s ability to increase its sales and gross profits while reducing its operating expenses.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s cash flows and other key indicators of liquidity are summarized as follows:

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	As Of And For The Nine Months Ended:
	September 30, 2008			September 30, 2007			% change vs. 2007
Cash flows from:
Operating activities	$	(2,116,000	)	$	(2,562,000	)		17	%
Investing activities		(871,000	)		(1,495,000	)		42	%
Financing activities		2,688,000			(369,000	)		828	%
Working capital		(836,000	)		352,000			-338	%
Current ratio		0.68	x		1.12	x		-39	%
Cash and cash equivalents	$	443,000		$	1,377,000			-68	%
Revolving credit notes	$	1,858,000		$	-
Funds Available from Open Credit Facilities	$	1,742,000		$	-

As of September 30, 2008, our cash and cash equivalents were approximately $443,000, down from approximately $742,000 at December 31, 2007. The decrease was primarily due to the use of cash for operations and the use of cash to defend the Company’s patent rights offset by the receipt of $2,358,000 from the Company’s three credit facilities. During the third quarter of 2008, the Company used $500,000 proceeds from the sale and assignment of certain of its patent rights to a third party to pay down one of its credit facilities. As of September 30, 2008, the Company had approximately $1.9 million outstanding under two credit agreements, which are due and payable over the next two years. As of September 30, 2008, the Company was in default of both agreements due to a failure to pay interest when due. Both Fagenson and Co., Inc. and Patrick White have agreed to waive the defaults through January 1, 2010.

	Payment Due by Period
	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Credit Facilities	$	1,858,000	$	-	$	1,858,000	$	-	$	-

The Company expects to continue to use cash for its operations and the remainder of 2008. In March 2008, the Company initiated a cost reduction program in order to bring its cash expenditures to a level closer to its current revenue base. As a result of these cost cuts, the Company has reduced its annual cash operating expense base by approximately $1.5 million. In addition, in August 2008, the Company sold 49% of its patent related to its ECB litigation to a third party in exchange for the third party’s commitment to fund nearly all of the remaining costs associated with pending litigation efforts. This agreement, while reducing the potential proceeds that the Company could receive upon a successful outcome of litigation by half, essentially eliminates the Company’s cash requirements for its ECB litigation efforts, which has historically been a significant use of cash for the Company.

As of September 30, 2008, the Company has an aggregate of $1,742,000 remaining available under two revolving notes that terminate on January 4, 2010. In addition, the Company has $1,300,000 in subscriptions receivable which it expects to receive in six-month installments over the next two years. Based on these funding sources, the Company believes that it has sufficient available funds to meet is cash needs for the at least the next twelve months.

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ITEM 3:   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The market risk disclosures as set forth in Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2007 have not changed materially.

ITEM 4 - CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Management is responsible for establishing and maintaining effective disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer participated with our management in evaluating the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on this evaluation, and in light of the material weaknesses in our internal control over financial reporting that are discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007 these officers have concluded that our disclosure controls and procedures were not effective. To address the material weaknesses described in Annual Report on Form 10-K for the fiscal year ended December 31, 2007, we performed additional analyses and other post-closing procedures to ensure our consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). Accordingly, management believes that the financial statements included in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial condition, result of operations and cash flows for the periods presented.

Changes in Internal Control Over Financial Reporting

During the second quarter of 2008, the Company eliminated the use of an outside consultant formerly used to enhance the segregation of duties for financial reporting. Concurrently, the Company modified and expanded one of its existing internal positions to accommodate some of the control objectives affected by the elimination of the outside consultant role. The Company will evaluate the effect of its changes in internal controls during its annual assessment of its internal controls.

PART II

OTHER INFORMATION

ITEM 1 - LEGAL PROCEEDINGS

Information concerning pending legal proceedings is incorporated herein by reference to Note 10 to the Condensed Consolidated Financial Statements (Unaudited) in Part I of this Form 10-Q.

On August 1, 2005, we commenced a suit against the European Central Bank (“ECB”) alleging patent infringement by the ECB and claimed unspecified damages. We brought the suit in European Court of First Instance in Luxembourg. We alleged that all Euro banknotes in circulation infringe the Company European Patent 0 455 750B1 (the “Patent”), which covers a method of incorporating an anti-counterfeiting feature into banknotes or similar security documents to protect against forgeries by digital scanning and copying devices. The Court of First Instance ruled on September 5, 2007 that it does not have jurisdiction to rule on the patent infringement claim, and also ruled that we will be required to pay attorneys and court fees of the ECB. The ECB formally requested the Company to pay attorneys and court fees in the amount of Euro 93,752 ($144,000), which, unless the amount is agreed will be subject to an assessment procedure that will not likely be concluded until approximately the end of 2008, which the Company will accrue as soon as the assessed amount, if any, is estimatable.

On March 24, 2006, we received notice that the ECB has filed a separate claim in the United Kingdom and Luxembourg courts seeking the invalidation of the Patent. Proceedings were commenced before the national courts seeking revocation and declarations ofinvalidityof the Patent in each of the Netherlands, Belgium, Italy, France, Spain, Germany and Austria. On March 26, 2007, the High Court of Justice, Chancery Division, Patents Court in London, England (the “English Court”) ruled that the Patent was deemed invalid in the United Kingdom, and on March 19, 2008 this decision was upheld on appeal. The English Court rejected the ECB’s allegations of invalidity based on lack of novelty, lack of inventive step and insufficiency, but held that the patent was invalid for added subject matter. The English Court’s decision does not affect the validity of the Patent in other European countries. On March 30, 2007, the English Court awarded the ECB 30% of their costs (including legal fees) of the initial trial, of which the Company paid 90,000 British pounds ($182,000) on April 19, 2007. We expect that an additional 90,000 pounds ($162,000 at September 30, 2008) will become payable by the Company for the costs of the initial trial, which is included in accrued expenses as of September 30, 2008. In July 2007, the Company posted a bond of 87,500 British pounds ($157,500 at September 30, 2008), as collateral for the appeal costs which is recorded as restricted cash at September 30, 2008. On June 19, 2008, the Company paid 87,500 British pounds ($177,000 based on the applicable exchange rate on that date) towards theECB’s costs of the English appeal. The Company may also owe additional legal fees associated with the Court of Appeal decisions, which, unless otherwise agreed by the parties, will be subject to an assessment procedure that will not likely be concluded earlier than the first quarter of 2009. The Company will record the assessed amount, if any, as soon as it is estimatable.

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On March 27, 2007 the Bundespatentgericht of the Federal Republic of Germany ruled that the German part of the Patent was valid, having considered the English Court’s decision. As a result of this ruling, the Company expects to be awarded reimbursements for its costs associated with the German validity case, which is Euro 44,692 ($64,000 at September 30, 2008), which the Company will record when the amount, if any, is received. The ECB has filed an appeal against that decision, which is not expected to be decided before 2010. On January 9, 2008 the French Court held that the Patent was invalid in France for the same reasons given by the English Court. The Company is required to pay de minimus attorneys’ fees of the ECB as a result of the French decision. The Company filed an appeal against the French decision on May 7, 2008. On March 12, 2008 the Dutch Court, having considered the English, German and French decisions, ruled that the Patent is valid in the Netherlands. The ECB filed an appeal against the Dutch decision on March 27, 2008. A trial was also held in Madrid, Spain on June 3 and 5, 2008 and oral and written closing submissions were made on July 19, 2008. A judgment is expected in the fourth quarter of 2008.

The Patent has thus been confirmed to be valid and enforceable in two jurisdictions (Germany and the Netherlands) that use the Euro as its national currency. Additional trials on the validity of the Patent are expected in other European jurisdictions in 2008 and 2009.

On August 20, 2008, the Company entered into an agreement with Trebuchet Capital Partners, LLC (“Trebuchet”) under which Trebuchet has agreed to pay substantially all of the litigation costs associated with pending validity proceedings initiated by the European Central Bank (“ECB”) in eight European countries relating to the Company’s European Patent 0 455 750B1 that the Company has claimed the ECB infringed in printing of the Euro currency (the “Patent”). Trebuchet also agreed to pay substantially all of the litigation costs associated with future validity challenges filed by the ECB or other parties, provided that Trebuchet elects to assume the defense of any such challenges, in its sole discretion, and patent infringement suits filed against the ECB and certain other alleged infringers of the Patent, all of which suits may be brought at the sole discretion of Trebuchet and may be in the name of the Company, Trebuchet or both. The Company provided Trebuchet with the sole and exclusive right to manage infringement litigation relating to the Patent in Europe, including the right to initiate litigation in the name of the Company, Trebuchet or both and to choose whom and where to sue, subject to certain limitations set forth in the agreement. Under the terms of the Agreement, the Company and Trebuchet have agreed to equally share all proceeds generated from litigation relating to the Patent, including judgments and licenses or other arrangements entered into in settlement of any such litigation. Trebuchet is also entitled to recoup any litigation expenses specifically awarded to the Company in such actions.

On January 31, 2003, the Company commenced an action, unrelated to the above ECB litigation, entitled New Sky Communications, Inc., As Successor-In-Interest To Thomas M. Wicker, Thomas M.Wicker Enterprises, Inc. and Document Security Consultants V. Adler Technologies, Inc. N/K/A Adlertech International, Inc. and Andrew McTaggert (United States District Court, Western District Of New York Case No.03-Cv-6044t(F)) regarding certain intellectual property in which the Company have an interest. The Company commenced this action alleging various causes of action against Adler Technologies, Inc. and Andrew McTaggert for breach of contract, breach of the duty of good faith and fair dealing, various business torts, including unfair competition and declaratory relief. Adler distributes and supplies anti-counterfeit document products and Mr. McTaggert is a principal of Adler. Adler had entered into several purported agreements with Thomas M. Wicker Enterprises and Document Security Consultants, both of which the Company acquired in 2002. These alleged agreements, generally, would have authorized Adler to manufacture in Canada the Company’s “Checkmate®” patented system for verifying the authenticity of currency and documents. Other purported agreements were signed between these parties and Thomas Wicker regarding other technology claimed to have been owned by Wicker and assigned to the Company. Among other things, the Company contends that certain of the purported agreements are not binding and/or enforceable. To the extent any of them are binding and enforceable, the Company claims that Adler has breached these purported agreements, failed to make an appropriate accounting and payments under them, and may have exceeded the scope of its license. Adler has denied the material allegations of the complaint and has counterclaimed against the Company, claiming Adler owns or co-owns or has a license to use certain of the Company’s technologies. In May 2005, the Company filed a first amended and supplemental complaint adding Blanks/USA and Raymond Maxon as additional defendants. In February 2007, the Company filed a second amended and supplemental complaint adding Judith Wu (McTaggert’s wife) and Arcis Digital Security, Inc. (a company in which Ms. Wu is involved) as additional defendants. Maxon has asserted a counterclaim against the Company contending that the Company’s purported acquisition of a certain patent from Thomas Wicker in 2002 gave rise to an alleged right on the part of Maxon to receive a portion of Thomas Wicker’s proceeds from such acquisition. The Company has denied the material allegations of all of the counterclaims. If Adler or Maxon is successful, it may materially affect the Company, the Company’s financial condition, and the Company’s ability to market and sell certain of the Company technology and related products. This case is in discovery phase, and it is too soon to determine how the various issues raised by the lawsuit will be determined.

In addition to the foregoing, we are subject to other legal proceedings that have arisen in the ordinary course of business and have not been finally adjudicated. Although there can be no assurance in this regard, in the opinion of management, none of these legal proceedings to which we are a party will have a material adverse effect on our results of operations, cash flows or our financial condition.

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ITEM 1A – RISK FACTORS

An investment in our securities is subject to numerous risks, including the Risk Factors described below. Our business, operating results or financial condition could be materially adversely affected by any of the following risks. The risks described below are not the only ones we face. Additional risks we are not presently aware of or that we currently believe are immaterial may also materially affect our business. The trading price of our Common Stock could decline due to any of these risks. In assessing these risks, you should also refer to the other information contained or incorporated by reference in this Form 10-Q, including our financial statements and related notes and information contained in our Form 10-K for the year ended December 31, 2007.

We have a limited operating history with our business model, which limits the information available to you to evaluate our business.

Since our inception in 1984, we have accumulated deficits from historical operations of approximately $30,397,000 at September 30, 2008. In 2002, we changed our business model and chose to strategically focus on becoming a developer and marketer of secure technologies for all forms of print media. We have continued to incur losses since we began our new business model. Also, we have limited operating and financial information relating to this new business to evaluate our performance and future prospects. Due to the change in our business model, we do not view our historical financials as being a good indication of our future. We face the risks and difficulties of a company going into a new business including the uncertainties of market acceptance, competition, cost increases and delays in achieving business objectives. There can be no assurance that we will succeed in addressing any or all of these risks, and the failure to do so could have a material adverse effect on our business, financial condition and operating results.

We have secured credit facilities that have large principal payments due and if we are unable to repay them with cash we may be forced to repay, in whole on in part, with each credit facility’s applicable collateral, which would have a material adverse effect on our financial position.

On January 4, 2008, we entered into two credit facilities with and aggregate borrowing capacity of $3.6 million that is repayable in full on January 4, 2010. One of these credit facilities has a borrowing limit of $3.0 million and is secured by our stock in our Plastic Printing Professionals, Inc. subsidiary (“P3”), and the other credit facility has a borrowing limit of $600,000 and is secured by our accounts receivable, excluding the accounts receivable of P3. As of September 30, 2008, the Company was in default of both agreements due to a failure to pay interest when due. Both Fagenson and Co., Inc. and Patrick White have agreed to waive the default through January 1, 2010. If we cannot generate sufficient cash from operations or raise cash from other sources, including without limitation, fund-raising through sales of equity, and if we cannot refinance the credit facilities, we may have to repay, in whole or in part, one or both of the credit facilities with each credit facility’s applicable collateral, which would have a material adverse effect on our financial position.

Due to our low cash balance and negative cash flow, we may have to further reduce our costs by curtailing future operations.

We have incurred significant net losses this year and previous years. Our ability to fund our capital requirements out of our available cash and cash generated from our operations depends on a number of factors. Some of these factors include our ability to (i) increase paper and plastic card sales and (ii) increase sales of our digital products. If we cannot generate positive cash flow from operations, we will have to continue to reduce our costs and raise working capital from other sources. These measures could include selling or consolidating certain operations or assets, and delaying, canceling or scaling back product development and marketing programs. These measures could materially and adversely affect our ability to operate profitably.

Our ability to effect a financing transaction to fund our operations could adversely affect the value of your stock.

If we seek additional financing through raising additional capital through public or private equity offerings or debt financing, such additional capital financing may not be available to us on favorable terms and our stockholders will likely experience substantial dilution. Material shortage of capital will require us to take steps such as reducing our level of operations, disposing of selected assets, effecting financings on less than favorable terms or seeking protection under federal bankruptcy laws.

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Our limited cash resources may not be sufficient to fund continuing losses from operations and the expenses of the current patent validity and patent infringement litigations.

The cost to defend and prosecute current and future patent litigation may be significant. We cannot assure you that the ultimate cost of current known or future unknown litigation and claims will not exceed our current expectations and/or our ability to pay such costs and it is possible that such litigation costs could have a material adverse effect on our business, financial condition and operating results. In addition, litigation is time consuming and could divert management attention and resources away from our business, which could adversely affect our business, financial condition and operating results.

If we lose our current litigation, we may lose certain of our technology rights, which may affect our business plan.

We are subject to litigation and alleged litigation, including without limitation our litigation with the European Central Bank, in which parties allege, among other things, that certain of our patents are invalid. For more information regarding this litigation, see Part II Item 1- Legal Proceedings. If the ECB or other parties are successful in invalidating any or all of our patents, it may materially affect us, our financial condition, and our ability to market and sell certain of our products based on any patent that is invalidated. Furthermore, we have granted nearly all control over our ECB Litigation a third party, Trebuchet Capital Partners, LLC., who may or may not have the resources or capabilities to successfully defend our patent rights.

If we lose our current validity or infringement litigation we may be liable for significant legal costs of our counterparts.

We have been able to mitigate the cash outlays that we have been required to make for legal costs of our current invalidity cases against the European Central Bank by, among other things, negotiating legal fee caps and using shares of our common stock for payments. However, if we receive adverse rulings in any of our infringement or related invalidity cases against the European Central Bank, we will likely be responsible for a large portion of the legal costs that were expended by the European Central Bank in such case, which would likely be significant, with our current estimates of between $1,000,000 to $2,000,000. The payment of these amounts could have a material adverse impact on our operations, cash available and liquidity.

If we are unable to adequately protect our intellectual property, our competitive advantage may disappear.

Our success will be determined in part by our ability to obtain United States and foreign patent protection for our technology and to preserve our trade secrets. Because of the substantial length of time and expense associated with developing new document security technology, we place considerable importance on patent and trade secret protection. We intend to continue to rely primarily on a combination of patent protection, trade secrets, technical measures, copyright protection and nondisclosure agreements with our employees and customers to establish and protect the ideas, concepts and documentation of software and trade secrets developed by us. Our ability to compete and the ability of our business to grow could suffer if these intellectual property rights are not adequately protected. There can be no assurance that our patent applications will result in patents being issued or that current or additional patents will afford protection against competitors. We rely on a combination of patents, copyrights, trademarks and trade secret protection and contractual rights to establish and protect our intellectual property. Failure of our patents, copyrights, trademarks and trade secret protection, non-disclosure agreements and other measures to provide protection of our technology and our intellectual property rights could enable our competitors to more effectively compete with us and have an adverse effect on our business, financial condition and results of operations. In addition, our trade secrets and proprietary know-how may otherwise become known or be independently discovered by others. No guarantee can be given that others will not independently develop substantially equivalent proprietary information or techniques, or otherwise gain access to our proprietary technology.

In addition, we may be required to litigate in the future to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Any such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our business, financial condition or results of operations, and there can be no assurances of the success of any such litigation.

We may face intellectual property infringement or other claims against us, our customers or our intellectual property that could be costly to defend and result in our loss of significant rights.

Although we have received or applied for U.S., European and International Patents with respect to certain technologies of ours, there can be no assurance that these patents will afford us any meaningful protection. Although we believe that our use of the technology and products we developed and other trade secrets used in our operations do not infringe upon the rights of others, our use of the technology and trade secrets we developed may infringe upon the patents or intellectual property rights of others. In the event of infringement, we could, under certain circumstances, be required to obtain a license or modify aspects of the technology and trade secrets we developed or refrain from using same. We may not have the necessary financial resources to defend an infringement claim made against us or be able to successfully terminate any infringement in a timely manner, upon acceptable terms and conditions or at all. Failure to do any of the foregoing could have a material adverse effect on us and our financial condition. Moreover, if the patents, technology or trade secrets we developed or use in our business are deemed to infringe upon the rights of others, we could, under certain circumstances, become liable for damages, which could have a material adverse effect on us and our financial condition. As we continue to market our products, we could encounter patent barriers that are not known today. A patent search will not disclose applications that are currently pending in the United States Patent Office, and there may be one or more such pending applications that would take precedence over any or all of our applications.

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Furthermore, third parties may assert that our intellectual property rights are invalid, which could result in significant expenditures by us to refute such assertions. If we become involved in litigation, we could lose our proprietary rights, be subject to damages and incur substantial unexpected operating expenses. Intellectual property litigation is expensive and time-consuming, even if the claims are subsequently proven unfounded, and could divert management’s attention from our business. If there is a successful claim of infringement, we may not be able to develop non-infringing technology or enter into royalty or license agreements on acceptable terms, if at all. If we are unsuccessful in defending claims that our intellectual property rights are invalid, we may not be able to enter into royalty or license agreements on acceptable terms, if at all. This could prohibit us from providing our products and services to customers, which could have a material adverse effect on us and our financial condition.

If our products and services do not achieve market acceptance, we may not achieve our revenue and net income goals in the time prescribed or at all.

We are at the early stage of introducing our document security technology and products to the market. If we are unable to operate our business as contemplated by our business model or if the assumptions underlying our business model prove to be unfounded, we could fail to achieve our revenue and net income goals within the time we have projected, or at all, which could have a material adverse effect on our business. As a result, the value of your investment could be significantly reduced or completely lost.

We cannot assure you that a sufficient number of companies will purchase our products or services or other document security products. In addition, we cannot predict the rate of market’s acceptance of our document security solutions. Failure to maintain a significant customer base may have a material adverse effect on our business.

Certain of our recently developed products are not yet commercially accepted and there can be no assurance that those products will be accepted, which would adversely affect our financial results.

Over the past one to two years, we have spent significant funds and time to create new products by applying our technologies onto media other than paper, including plastic and cardboard packaging, and delivered our technologies digitally. We have had limited success in selling our products that are on cardboard packaging and those that are delivered digitally. If we are not able to successfully sell these new products, our financial results will be adversely affected.

The results of our research and development efforts are uncertain and there can be no assurance of the commercial success of our products.

We believe that we will need to continue to incur research and development expenditures to remain competitive. The products we currently are developing or may develop in the future may not be technologically successful. In addition, the length of our product development cycle may be greater than we originally expect and we may experience delays in future product development. If our resulting products are not technologically successful, they may not achieve market acceptance or compete effectively with our competitors’ products.

Changes in document security technology and standards could render our applications and services obsolete.

The market for document security products, applications, and services is fast moving and evolving. Identification and authentication technology is constantly changing as we and our competitors introduce new products, applications, and services, and retire old ones as customer requirements quickly develop and change. In addition, the standards for document security are continuing to evolve. If any segments of our market adopt technologies or standards that are inconsistent with our applications and technology, sales to those market segments could decline, which could have a material adverse effect on us and our financial condition.

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The market in which we operate is highly competitive, and we may not be able to compete effectively, especially against established industry competitors with greater market presence and financial resources.

Our market is highly competitive and characterized by rapid technological change and product innovations. Our competitors may have advantages over us because of their longer operating histories, more established products, greater name recognition, larger customer bases, and greater financial, technical and marketing resources. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements, and devote greater resources to the promotion and sale of their products. Competition may also force us to decrease the price of our products and services. We cannot assure you that we will be successful in developing and introducing new technology on a timely basis, new products with enhanced features, or that these products, if introduced, will enable us to establish selling prices and gross margins at profitable levels.

Our growth strategy depends, in part, on our acquiring complementary businesses and assets and expanding our existing operations to include manufacturing capabilities, which we may be unable to do.

Our growth strategy is based, in part, on our ability to acquire businesses and assets that are complimentary to our existing operations and expanding our operations to include manufacturing capabilities. We may also seek to acquire other businesses. The success of this acquisition strategy will depend, in part, on our ability to accomplish the following:

· identify suitable businesses or assets to buy;

· complete the purchase of those businesses on terms acceptable to us;

· complete the acquisition in the time frame we expect; and

· improve the results of operations of the businesses that we buy and successfully integrate their operations into our own.

Although we were able to successfully acquire our Plastic Printing Professionals, Inc. subsidiary in February 2006, there can be no assurance that we will be successful in pursuing any or all of these steps on future transactions. Our failure to implement our acquisition strategy could have an adverse effect on other aspects of our business strategy and our business in general. We may not be able to find appropriate acquisition candidates, acquire those candidates that we find or integrate acquired businesses effectively or profitably.

Our acquisition program and strategy may lead us to contemplate acquisitions of companies in bankruptcy, which entail additional risks and uncertainties. Such risks and uncertainties include, without limitation, that, before assets may be acquired, customers may leave in search of more stable providers and vendors may terminate key relationships. Also, assets are generally acquired on an “as is” basis, with no recourse to the seller if the assets are not as valuable as may be represented. Finally, while bankrupt companies may be acquired for comparatively little money, the cost of continuing the operations may significantly exceed expectations.

We have in the past used, and may continue to use, our Common Stock as payment for all or a portion of the purchase price for acquisitions. If we issue significant amounts of our Common Stock for such acquisitions, this could result in substantial dilution of the equity interests of our stockholders.

If we fail to retain our key personnel and attract and retain additional qualified personnel, we might not be able to pursue our growth strategy.

Our future success depends upon the continued service of our executive officers and other key sales and research personnel who possess longstanding industry relationships and technical knowledge of our products and operations. The loss of any of our key employees, in particular, Patrick White, our Chief Executive Officer and David Wicker, our Vice-President of Operations, could negatively impact our ability to pursue our growth strategy and conduct operations. Although we believe that our relationship with these individuals is positive, there can be no assurance that the services of these individuals will continue to be available to us in the future. We have extended our employment agreements with Patrick White to June 2009. Our employment agreement with David Wicker expires in June 2009. There can be no assurance that these persons will continue to agree to be employed by us after such dates.

Future growth in our business could make it difficult to manage our resources.

Our anticipated business expansion could place a significant strain on our management, administrative and financial resources. Significant growth in our business may require us to implement additional operating, product development and financial controls, improve coordination among marketing, product development and finance functions, increase capital expenditures and hire additional personnel. There can be no assurance that we will be able to successfully manage any substantial expansion of our business, including attracting and retaining qualified personnel. Any failure to properly manage our future growth could negatively impact our business and operating results.

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We cannot predict our future capital needs and we may not be able to secure additional financing.

We may need to raise additional funds in the future to fund more aggressive expansion of our business, complete the development, testing and marketing of our products, or make strategic acquisitions or investments. We may require additional equity or debt financings, collaborative arrangements with corporate partners or funds from other sources for these purposes. No assurance can be given that these funds will be available for us to finance our development on acceptable terms, if at all. Such additional financings may involve substantial dilution of our stockholders or may require that we relinquish rights to certain of our technologies or products. In addition, we may experience operational difficulties and delays due to working capital restrictions. If adequate funds are not available from operations or additional sources of financing, we may have to delay or scale back our growth plans. In June 2008, we sold 350,000 shares for an aggregate purchase price of $1.4 million, with $100,000 payable at closing and the remaining $1.3 million payable in six-month installments over two years. If the Purchaser of such 350,000 does not pay some or all of such remaining $1.3 million purchase price, we will have limited, if any, recourse against the purchaser other than recouping a pro-rata amount of the 350,000 shares. If we do not receive the remaining $1.3 million of the purchase price on schedule, our financial position and financing resources may be materially adversely affected.

Risks Related to Our Stock

Provisions of our certificate of incorporation and agreements could delay or prevent a change in control of our company.

Certain provisions of our certificate of incorporation may discourage, delay, or prevent a merger or acquisition that a stockholder may consider favorable. These provisions include:

· the authority of the Board of Directors to issue preferred stock; and

· a prohibition on cumulative voting in the election of directors.

We have a large number of authorized but unissued shares of common stock, which our management may issue without further stockholder approval, thereby causing dilution of your holdings of our common stock.

As of September 30, 2008, there are approximately 185 million shares of authorized but unissued shares of our common stock. Our management will continue to have broad discretion to issue shares of our common stock in a range of transactions, including capital-raising transactions, mergers, acquisitions, for anti-takeover purposes, and in other transactions, without obtaining stockholder approval, unless stockholder approval is required for a particular transaction under the rules of the American Stock Exchange, New York law, or other applicable laws. We currently have no specific plans to issue shares of our common stock for any purpose. However, if our management determines to issue shares of our common stock from the large pool of such authorized but unissued shares for any purpose in the future without obtaining stockholder approval, your ownership position would be diluted without your further ability to vote on that transaction.

The exercise of our outstanding options and warrants and vesting of restricted stock awards may depress our stock price.

As of September 30, 2008, there were outstanding stock options and warrants to purchase an aggregate of 1,306,343 shares of our Common Stock at exercise prices ranging from $2.20 to $12.65 per share and a weighted average exercise price of $10.24. In addition, as of September 30, 2008, there were 237,793 restricted shares of our common stock that are subject to various vesting terms. To the extent that these securities vest, dilution to our stockholders will occur. Moreover, the terms upon which we will be able to obtain additional equity capital may be adversely affected, since the holders of these securities can be expected to exercise or convert them at a time when we would, in all likelihood, be able to obtain any needed capital on terms more favorable to us than the exercise and conversion terms provided by those securities.

Sales of these shares in the public market, or the perception that future sales of these shares could occur, could have the effect of lowering the market price of our common stock below current levels and make it more difficult for us and our stockholders to sell our equity securities in the future.

Sale or the availability for sale of shares of common stock by stockholders could cause the market price of our common stock to decline and could impair our ability to raise capital through an offering of additional equity securities.

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We do not intend to pay cash dividends.

We do not intend to declare or pay cash dividends on our common stock in the foreseeable future. We anticipate that we will retain any earnings and other cash resources for investment in our business. The payment of dividends on our common stock is subject to the discretion of our Board of Directors and will depend on our operations, financial position, financial requirements, general business conditions, restrictions imposed by financing arrangements, if any, legal restrictions on the payment of dividends and other factors that our Board of Directors deems relevant.

ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On August 20, 2008, the Company entered into an agreement with Trebuchet Capital Partners, LLC which agreed to pay substantially all of the litigation costs associated with pending validity proceedings initiated by the ECB in eight European countries relating to the Company’s European Patent 0 455 750B1 that the Company has claimed the ECB infringed in printing of the Euro currency. Trebuchet has also purchased 100,000 shares of the Company’s common stock, subject to the American Stock Exchange approving the listing of such shares, for an aggregate purchase price of $400,000, the proceeds of which will be used by the Company to pay existing, accrued costs related to the Litigation. On July 18, 2008, the Company issued 19,266 shares to a vendor as payment for $94,000 of the vendor’s outstanding bills.

ITEM 3 - DEFAULTS UPON SENIOR SECURITIES

On January 4, 2008, the Company entered into a Credit Facility Agreement with Fagenson and Co., Inc., as agent, a related party to Robert B. Fagenson, the Chairman of the Company's Board of Directors. Under the Fagenson Credit Agreement, the Company can borrow up to a maximum of $3,000,000 from time to time up to and until January 4, 2010. The advances are generally limited to $400,000 unless otherwise mutually agreed upon by both parties per fiscal quarter, with the exception of $600,000 that can be advanced at any time for patent litigation related bills. Any amount borrowed by the Company pursuant to the Fagenson Credit Agreement will have an annual interest rate of 2% above LIBOR and will be secured by the Common Stock of Plastic Printing Professionals, Inc., (“P3”) the Company's wholly owned subsidiary. Interest is payable quarterly in arrears and the principal is payable in full at the end of the term under the Fagenson Credit Agreement. In addition, on January 4, 2008, the Company also entered into a Credit Facility Agreement with Patrick White, the Company's Chief Executive Officer and a member of the Board of Directors. Under the White Credit Agreement, the Company can borrow up to $600,000 from time to time up to and until January 4, 2010. Any amount borrowed by the Company pursuant to the White Credit Agreement will have an annual interest rate of 2% above LIBOR and will be secured by the accounts receivable of the Company, excluding the accounts receivable of P3. Interest is payable quarterly in arrears and the principal is payable in full at the end of the Term under the White Credit Agreement. Mr. White can accept common stock as repayment of the loan upon a default. Under the terms of the agreement the Company is required to comply with various covenants. During the year ended December 31, 2007, Patrick White advanced the Company $300,000 while the terms of the credit facility were being finalized. As of September 30, 2008, the Company was in default of both agreements due to a failure to pay interest when due. Both Fagenson and Co., Inc. and Patrick White have agreed to waive the default through January 1, 2010.

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5 - OTHER INFORMATION

None       

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ITEM 6 - EXHIBITS

The Exhibits listed below designated by an * are incorporated by reference to the filings by Document Security Systems, Inc. under the Securities Act of 1933 or the Securities and Exchange Act of 1934, as indicated. All other exhibits are filed herewith.

(a)Exhibits

Item 3.1 Articles of Organization of the Registrant, as amended (incorporated by reference to exhibit 3.1 to the Company's Registration Statements No. 2-98684-NY on Form S-18).*

Item 3.2 By-laws of the Registrant, as amended (incorporation by reference to exhibit 3.2 to the Company's Registration Statement No. 2-98684-NY on Form S-18).*

Item 10.1 Agreement, dated August 20, 2008, between Document Security Systems, Inc. and Trebuchet Capital Partners, LLC

Item 31.1 Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes Oxley Act

Item 31.2 Certifications of Acting Chief Financial Officer Pursuant to Section 302 of the Sarbanes Oxley Act

Item 32.1Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes Oxley Act

Item 32.2Certification of Acting Chief Financial Officer Pursuant to Section 906 of the Sarbanes Oxley Act

SIGNATURES

            In accordance with the requirements of the Exchange Act, the registrant caused this report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized.

		DOCUMENT SECURITY SYSTEMS, INC.
November 10, 2008	By:	/s/ Patrick White
		Patrick White Chief Executive Officer
November 10, 2008	By:	/s/ Philip Jones
		Philip Jones
		Acting Chief Financial Officer (Vice President of Finance)

 

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EX-10.1

AGREEMENT

This Agreement (the “Agreement”) is executed on August 20, 2008 and made effective as of the Effective Date (as defined below), by and between Document Security Systems, Inc., a New York corporation (“DSS”), having an office at 28 East Main Street, Suite 1525, Rochester, New York 14614, and Trebuchet Capital Partners, LLC, a limited liability company formed under the laws of Delaware (“TREBUCHET”), having an office at 609-3 Cantiague Rock Road, Westbury, New York 11590. DSS and TREBUCHET are together referred to herein as the “Parties” or either of them as the context makes clear is referred to as a “Party.”

RECITALS

WHEREAS, DSS is the owner of a certain Patent (hereinafter defined);

WHEREAS, DSS believes that multiple entities in Europe, including, without limitation, the European Central Bank (the “ECB”), have infringed upon the Patent with respect to the Euro and certain other world currencies;

WHEREAS, on August 1, 2005, DSS initiated a patent infringement lawsuit against the ECB in the Court of First Instance, which lawsuit was dismissed on September 5, 2007, for lack of jurisdiction;

WHEREAS, in March 2006, the ECB initiated proceedings in nine European jurisdictions to invalidate the Patent (the “Validity Proceedings”), which has resulted in the Patent being declared valid in Germany and The Netherlands and invalid in the United Kingdom and France, and the determinations in Germany, The Netherlands and France are, as of the date of this Agreement, on appeal;

WHEREAS, DSS has expended significant financial and management resources with respect to such infringement lawsuit and Validity Proceedings;

WHEREAS, management and the Board of Directors of DSS (the “Board”) have determined that DSS does not currently have the required additional financial resources to effectively defend the Validity Proceedings and otherwise assert the Patent against all past, present and potential infringers, including but not limited to the ECB, on its own without raising funds on terms that may, and in the view of the Board likely would, not be acceptable to, or in the best interest of, DSS and its shareholders, taking into account all relevant factors, including without limitation, the potential for significant dilution to DSS shareholders;

WHEREAS, DSS has determined that it has significant opportunities to expand its current operating businesses and that such expansion of business will consume significant amounts of management’s time and DSS’ resources;

WHEREAS, management and the Board have determined, based upon advice provided by legal counsel, that DSS has a strong legal basis to defend the Patent against validity challenges and to assert the Patent against infringers;

WHEREAS, DSS has been advised by legal counsel that time is of the essence in order to effectively defend the Patent against validity challenges and to assert the Patent against infringers;

WHEREAS, TREBUCHET has expressed a desire to provide significant financial and management resources in order to defend the Patent against the Validity Proceedings and to assert the Patent against infringers, on the terms as provided herein;

WHEREAS, TREBUCHET has conditioned its entering into this Agreement on TREBUCHET having an ownership interest in the Patent and the exclusive right and license to sue and recover, for the benefit of both TREBUCHET and DSS as separate owners of the Patent, for any and all past, present and future infringement of the Patent, along with a security interest in the Patent and in any and all past, present or future recoveries resulting from the assertion of the Patent, and the sole authority to make all decisions relating to the European Litigation and to the Patent, including, without limitation, the right to sublicense the Patent as warranted to resolve infringement claims, all as more specifically provided for herein;

WHEREAS, management and the Board has determined, after taking into account, among other things, its limited financial resources to properly fund the defense of the Validity Proceedings and the assertion of the Patent, that it is in the best interest of DSS and its shareholders to enter into this Agreement with TREBUCHET pursuant to the terms and conditions contained herein;

WHEREAS, in consideration of such funding, TREBUCHET will have full authority to manage and resolve on behalf of DSS (and on its own behalf) the now existing and any future challenges to the validity of the Patent by the Persons identified in Schedule 1 and the contemplated future assertions of the Patent against the Persons identified in Schedule 1 (which Persons include the ECB), and will share equally in revenue derived as a result of such activities as more specifically provided herein, as well as have the sole right to reimbursement of its fees and costs associated therewith if awarded by the relevant Courts; and

WHEREAS, the parties desire to formalize their respective rights and obligations as they relate generally to the exploitation of the rights in the Patent, including but not limited to the licensing thereof in connection with the now existing and contemplated proceedings, as they relate specifically to the defense of the validity of the Patent and to the assertion of the Patent, and to any and all related proceedings and appeals.

NOW, THEREFORE, in consideration of the mutual promises of the parties, and of other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, it is agreed by and between the parties as follows:

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ARTICLE 1

DEFINITIONS

For the purpose of this Agreement the following capitalized terms are defined in this Article 1 and shall have the meaning specified herein:

1.1 APPLICABLE LAWS. “Applicable Laws” means any federal, state, local, municipal, foreign, international, multinational or other law, statute, constitution, principle of common law, resolution, ordinance, code, edict, decree, rule, regulation, ruling or requirement issued, enacted, adopted, promulgated, implemented or otherwise put into effect by or under the authority of any governmental authority or agency.

1.2 CONTRACT. “Contract” means any written, oral or other agreement, contract, subcontract, lease, understanding, instrument, note, warranty, license, sublicense, insurance policy, benefit plan or legally binding commitment or undertaking of any nature, whether express or implied.

1.3 EFFECTIVE DATE. “Effective Date” means the date this Agreement was executed as noted in the Preamble of this Agreement.

1.4 EUROPEAN LITIGATION. The “European Litigation” means:

(a) patent invalidity proceedings filed by the ECB with respect to the Patent, and any appeals related thereto, which actions are identified in Schedule 2,

(b) patent assertion litigation currently pending and in the future to be filed against the ECB with respect to the Patent, which currently pending actions are identified in Schedule 3,

(c) future proceedings or litigations that may be brought by the ECB seeking a declaration of invalidity or non-infringement with respect to the Patent,

(d) future proceedings or litigations that may be brought by Persons identified in Schedule 1 (other than the ECB) alleging invalidity of the Patent and/or seeking a declaration of non-infringement with respect to the Patent, it being understood that TREBUCHET shall also have the right to defend against validity challenges brought by persons not identified in Schedule 1,

(e) future proceedings or litigations that may be brought against the Persons identified in Schedule 1 (other than the ECB) alleging infringement by said Persons of the Patent,

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(f) future proceedings or litigations as the Parties may from time to time agree in writing.

It is understood that the term European Litigation includes facilitating non-litigious or other alternative means of resolving disputes against any Person or Persons identified in Schedule 1 (including the ECB), and thus does not necessarily mandate the commencement of an actual proceeding or litigation.

1.5 MATERIAL ADVERSE EFFECT. “Material Adverse Effect” means any event, change or effect that is materially adverse to the condition (financial or otherwise), properties, assets, liabilities, business, operations or results of operations of DSS and its Subsidiaries, taken as a whole.

1.6 NON-DISCLOSURE AGREEMENT. “Non-Disclosure Agreement” means that certain Mutual Non-Disclosure Agreement entered into between TREBUCHET and DSS on July 11, 2008 and made effective as of the date stated therein.

1.7 PERSON(S). “Person(s)” means a natural person, a partnership, a corporation, a limited liability company, an association, a joint stock company, a trust, a joint venture, an unincorporated organization or a governmental entity or any department, agency or political subdivision thereof as otherwise indicated in this Agreement, or the affiliate of any such Person. “Affiliate” as used herein means a natural person, a partnership, a corporation, a limited liability company, an association, a joint stock company, a trust, a joint venture, an unincorporated organization or a governmental entity or any department, agency or political subdivision thereof as otherwise indicated in this Agreement controlled by, controlling or under the common control of the Person. The term “Control” as used herein means having the power to direct the affairs or the policies of the Person.

1.8 SUBSIDIARIES. “Subsidiaries” means DSS’s subsidiaries listed on Schedule 4.

1.9 THIRD PARTY LICENSEE. “Third Party Licensee” means any licensee of DSS and TREBUCHET with respect to the Patent under a Third Party License Agreement, whether or not such agreement was entered into after the Effective Date of this Agreement, with any Persons identified in Schedule 1.

1.10 PATENT. The “Patent” means European Patent No. 0455750 and the patents that were designated therein in the national contracting states of the European Union, as more specifically identified in Schedule 5.

1.11 TRANSACTION DOCUMENTS. “Transaction Documents” means this Agreement, the Non-Disclosure Agreement, any document which the Parties hereto may need to enter into to effectuate this Agreement including without limitation documents to confirm the assignment of an interest in the Patent and a security interest and/or lien in the remaining interest in Patent and proceeds thereof as herein provided.

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ARTICLE 2

COVENANTS

2.1 PATENT ASSIGNMENT AND RELATED COVENANTS

In consideration for TREBUCHET’s agreement to fund the European Litigation as more specifically provided under this Agreement,

(a)   DSS hereby transfers and assigns to TREBUCHET 49% (Forty Nine Percent) of all of its right, title and interest in the Patent and to the inventions described and claimed therein, such that both DSS and TREBUCHET shall each have a separate and distinct interest in and share of the Patent, along with the right to sue and recover in litigation, settlement or otherwise to collect royalties or other payments under or on account of the Patent and/or any of the foregoing, subject to the provisions for sharing any said recovery including royalties as provided in this Agreement, for all past, present and future causes of action including but not limited to actions asserting the infringement of the Patent.

(b)   With respect to DSS’s remaining 51% (Fifty One Percent) interest in the Patent, DSS grants to TREBUCHET the exclusive right and license to sue in the name of DSS, and to recover in litigation, settlement or otherwise to collect royalties or other payments under or on account of the Patent and/or any of the foregoing, subject to the provisions for sharing any said recovery including royalties as provided in this Agreement, for all past, present and future causes of action including but not limited to actions asserting the infringement of the Patent. DSS also grants to TREBUCHET the exclusive right and license (even as against DSS) to grant sublicenses or other rights under the Patent in compromise of or to resolve all past, present and future causes of action as warranted including but not limited to actions asserting the infringement of the Patent subject to the limitations otherwise set forth in this Agreement in subparagraph 2.2(b) below. With respect to the foregoing, it is understood that same does not prohibit DSS on its own account from practicing or using the Patent.

(c)   DSS hereby agrees that it shall not hereinafter assign, transfer or license its remaining interest in the Patent or otherwise encumber its remaining interest the Patent in any way and acknowledges that any such assignment, transfer, license or encumbrance may materially impact the rights of TREBUCHET and would be a material breach of this Agreement. DSS further agrees that it shall not, without the written permission of TREBUCHET, grant any licenses of the Patent.

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The assignment of an interest in the Patent and the exclusive license of rights as provided hereinabove shall be recorded, as needed, by filing in the respective national European contracting states where the Patent is in force or where otherwise appropriate a confirmatory patent assignment in the form necessary to comport with the filing requirements of each national European contracting state where the Patent is in force in which the assignment may need to be officially recorded.

2.2 MANAGEMENT AND COSTS.

(a) TREBUCHET shall have the sole and exclusive right (even as against DSS) and authority on behalf of DSS and in its own behalf as an owner of the Patent to control the management of the European Litigation, including, without limitation, the right to determine strategy including when to sue, where to sue, which Person or Persons identified in Schedule 1 to sue, hire or fire counsel, hire or fire experts, and otherwise make all decisions regarding the handling of any and all proceedings and litigations, including, without limitation, whether to commence proceedings or litigations identified in Schedule 8, whether to maintain or defend now existing proceedings and litigations identified in Schedule 8, and the resolution of the proceedings and litigations via settlement. TREBUCHET shall have the full authority to determine whether to seek review or appeal a determination in any such proceedings or litigations. TREBUCHET may in its discretion investigate the legal basis of the claims to be made, may investigate the capacity of the Persons identified in Schedule 1 to meet any award or order made against them relating to the claims, may investigate the interest of the Persons identified in Schedule 1 to resolve the claims by non-litigious means and may investigate any other matters relevant to such claims.

 (b) TREBUCHET may on behalf of DSS and on its own behalf consent to entry of any judgment or consent to enter into any settlement or to compromise any claim related to the Patent with respect to the Persons identified in Schedule 1 or to the European Litigation without DSS’ consent including without limitation granting rights under the Patent; provided that TREBUCHET shall obtain DSS’ prior consent if the effect of such judgment or settlement is to (i) permit any injunction, declaratory judgment, other order or other non-monetary relief to be entered, directly or indirectly, against DSS, (ii) require the payment by DSS of future royalties or any other payments in excess of $5,000 in the aggregate, (iii) require DSS to make any payment not fully indemnified under this Agreement (other than payments made or costs incurred by DSS pursuant to Article 5), (iv) require DSS to grant any rights other than in the Patent to any Person, including but not limited pursuant to a license to any of its intellectual property other than the Patent, or (v) otherwise affect the business, financial condition (including, but not by way of limitation, to require DSS to provide ECB or any Person with debt, convertible debt or equity in DSS) or operations of DSS or the rights of Third Party Licensees, in each case under this sub-clause (v) in a material way.

(c) TREBUCHET shall, as of the Effective Date, have received capital in the amount not less than * and TREBUCHET shall, within the first six months following the Effective Date after payment of the loan to Taiko III Corp. as provided in Article 2.2(d)2)(i), have completed its review of all pending and potential proceedings and claims related to the Patent against the Persons identified in Schedule 1 and commenced its consideration with legal counsel of the manner to implement the strategy TREBUCHET adopts, in its sole discretion, to satisfy its undertakings under this Agreement.

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(d) Except as otherwise noted herein, beginning on the Effective Date, TREBUCHET shall bear all fees and expenses including without limitation attorneys’ fees, expert witness fees, court costs, translation fees, costs for the posting of bonds and all expenses associated with the posting of bonds which may be necessary for the commencement of, or otherwise related to, proceedings, and any outstanding and future orders to pay fees or costs related to the European Litigation (“Expenses”) that are or may be incurred.

1) DSS understands and agrees that the following shall not be included as Expenses:

(i) the value of the time of DSS employees, consultants, and independent contractors spent or to be spent on the European Litigation, provided, however, that TREBUCHET shall be responsible for those future expenses that are associated with Dr. Robert Vasl as are set forth in Schedule 6, and

(ii) any expenses associated with DSS’ hiring or use of its own independent counsel or other advisors for the European Litigation (i.e., counsel different than the counsel selected and managed by TREBUCHET), provided that this clause (ii) does not limit TREBUCHET’s undertakings under Sections 2.2 of this Agreement, and

(iii) the ECB’s fees and expenses, including without limitation attorneys’ fees, with respect to the trial and appeal in the United Kingdom relating to the validity of the Patent or to the trial in France relating to the validity of the Patent, whether becoming the obligation of DSS as a result of a court order or otherwise; provided, however, that fees or expenses, including without limitation attorneys’ fees, that are paid or reimbursed to DSS or TREBUCHET related to the validity trial in Germany shall be solely for the account of DSS whether such fees and expenses are paid as a result of a court order or otherwise except pursuant to an agreement entered into after the date hereof by DSS without the prior written permission of Trebuchet.

2) In no event shall TREBUCHET be obligated to reimburse DSS for or to pay any invoices for any fees or expenses incurred by DSS prior to the Effective Date and all such fees and expenses incurred before such date shall remain the obligation of DSS, provided, however, the Parties agree that Trebuchet shall, on the Effective Date:

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(i) pay the full amount of $500,000, plus accrued interest thereon, owed by DSS to Taiko III Corp., thereby eliminating in full any and all indebtedness of DSS to Taiko III Corp and;

(ii) pay to DSS $400,000 in immediately available funds (the “ECB AP Amount”), representing substantially all of the accrued but unpaid fees and expenses previously incurred by DSS as indicated on Schedule 7, which ECB AP Amount shall be used by DSS solely to pay and satisfy said accrued but unpaid fees and expenses identified in Schedule 7. In consideration of this subparagraph, DSS shall issue to TREBUCHET 100,000 shares of DSS common stock (the “DSS Shares”). Within four (4) business days after the Effective Date, DSS shall file all such necessary documents with the American Stock Exchange to authorize the listing of the DSS Shares on the American Stock Exchange, if such documents had not been filed prior to the Effective Date. Promptly after DSS has received the approval from the American Stock Exchange for the listing of the DSS Shares, but in no event prior to the Effective Date, DSS shall deliver or cause to be issued in the name of TREBUCHET one or more stock certificates evidencing the DSS Shares, registered in the name of TREBUCHET (the "Certificates"). DSS shall also provide TREBUCHET with proof of payment of the unpaid fees and expenses indicted in said schedule within 30 days after the Effective Date of this Agreement.

3) TREBUCHET shall have no obligation to reimburse DSS for any costs or expenses incurred by DSS subsequent to the entry of this Agreement in connection with the European Litigation unless approved in advance in writing by TREBUCHET.

4) In connection with all of the foregoing funding undertakings, TREBUCHET has relied on the informed assumptions made by DSS in Schedule 8 as to the anticipated Costs associated with funding the European Litigation, and consequently its undertakings herein are premised solely on DSS’ informed assumptions. TREBUCHET’s undertaking to fund any one or more of the Proposed Infringement Proceedings and pending Validity Proceedings identified in Schedule 8 which in its sole and exclusive judgment it may determine to undertake and / or continue to defend is conditioned on the understanding that the assumptions made by DSS are reasonably accurate. TREBUCHET’s undertaking to fund any said proceedings if it so elects to undertake same shall not unreasonably exceed the estimates provided in said Schedule.

5) DSS shall be responsible for the payment of and shall pay all and any annuities, maintenance fees or other fees (collectively, the “Annuities”), however they are denominated, to keep the Patent in force in each of the national contracting states of the European Union where the Patent is in force as the Effective Date of the Agreement and where actions against the Persons listed in Schedule 1 are contemplated. TREBUCHET shall have the right but not the obligation to make those payments on behalf of DSS and deduct such Annuities from monies otherwise due DSS if requested by DSS.

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6) As a condition precedent to TREBUCHET’s funding undertakings herein, DSS shall take all steps necessary to ensure that the engagement letter with regard to the Validity Proceedings between McDermott, Will & Emery LLP (“MWE”) and DSS shall remain in effect and that MWE shall continue to zealously defend all Validity Proceedings against the Patent. As a further condition precedent to TREBUCHET’s funding undertakings herein, DSS shall deliver to TREBUCHET a letter from MWE acknowledging its ongoing obligations irrespective of this Agreement and its willingness to take direction in such Validity Proceedings from TREBUCHET.

(e) TREBUCHET shall provide to DSS’ Board of Directors a monthly report in a form to be mutually agreed upon in good faith, or more frequently at TREBUCHET’s discretion, on the European Litigation. Without limiting the terms of Section 2.1(a) above, TREBUCHET agrees to consult with DSS at its reasonable request. Without limiting the foregoing in this Section 2.1(c), immediately upon execution of any agreement or issuance of any court order relating to the Patent, TREBUCHET shall inform DSS of the material terms of the same and provide a true copy of any documents.

(f) DSS acknowledges and agrees that TREBUCHET is capable of fulfilling the undertakings and responsibilities undertaken by it in this Article with respect to the control and management of the European Litigation and waives any and all rights, claims and remedies relating to the control and management of the European Litigation by TREBUCHET. DSS acknowledges and agrees that Robert Girards shall act on behalf of TREBUCHET to manage and control the European Litigation, and that his duties and activities on behalf of TREBUCHET do not and will not impinge on any duties he may have at DSS.

2.3 COOPERATION

(a) Each Party shall cooperate fully with the other Party in connection with the European Litigation in a manner that will preserve any and all attorney-client or other privilege and attorney work product protection thereto, including the joint defense privilege, litigation privilege and/or common-interest privilege. DSS shall direct all present counsel in connection with the European Litigation to cooperate fully with TREBUCHET, to open their files to TREBUCHET, to fully inform TREBUCHET with respect to the issues to be addressed and decisions to be made in connection with the European Litigation, to respond to all inquires of TREBUCHET and otherwise provide information, documentation and assistance to TREBUCHET and to interface with TREBUCHET as if TREBUCHET had stepped into the shoes of DSS. DSS shall direct present counsel in connection with the European Litigation to take instructions from TREBUCHET.

(b) In the event that either Party receives any notice or other communication in connection with the European Litigation that may affect the other Party’s rights and undertakings under this Agreement or in any proceeding in the European Litigation, such Party promptly but in no event less than two (2) business days, shall notify the other Party and provide a copy of such notice or communication or, if oral, information about such notice or communication in reasonable detail.

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(c) DSS agrees to afford to TREBUCHET and to all counsel in the European Litigation reasonable access to witnesses, including but not limited to access to inventors of the Patent who are employed by DSS, and to information and documents, including but not limited to patent file histories, prior art and studies conducted by counsel, that is reasonably required in connection with the European Litigation. The foregoing includes, but is not limited to, an obligation to provide witnesses and information as necessary for trial and other proceedings, and documents to support the assertions or defense, and/or to assist counsel in responding to discovery requests, as the case may be. TREBUCHET shall be solely responsible for, and shall promptly reimburse, all actual, out-of-pocket expenses incurred by DSS in its satisfaction of this Section 2.3(c), provided that any costs for which reimbursement hereafter may be claimed, if in excess of $500.00, shall have been approved in advance by Trebuchet in writing.

(d) DSS agrees to be a named plaintiff in any Patent infringement action in the European Litigation and to cooperate fully with TREBUCHET’s counsel in the European Litigation as such counsel may request. DSS understands that it may be the sole plaintiff in the European Litigation or a co-plaintiff or that the action may be taken solely in the name of TREBUCHET, as warranted.

(e) The Parties will also execute all documents and do all things that either of them from time to time reasonably requires of the other to effect, perfect or complete the provisions of this Agreement and any transaction or proceedings contemplated thereby including but not limited to recording a confirmatory patent assignment and patent security agreement in each of the contacting states of the European Union if and where appropriate.

(f) *

(g) At the reasonable request of TREBUCHET, DSS will execute and deliver such other instruments and do and perform such other lawful acts and things as may be necessary or desirable for effecting completely the consummation of the transactions contemplated hereby, including, without limitation, execution, acknowledgment, and recordation of other such papers, and using commercially reasonable efforts to obtain the same from the respective inventors, as necessary or desirable for fully perfecting and conveying unto TREBUCHET the benefit of the transactions contemplated hereby.

2.4 REVENUE GENERATED AND PAID

(a) To the extent that revenue is generated by the European Litigation or from the ECB and other Persons identified in Schedule 1 after the Effective Date of this Agreement either by way of settlement, be that lump sum payments, advances, royalties, and/or other payment structures, including but not limited to license revenue such as advances or future royalties paid over time as the case may be, as well as revenue specifically attributable to past infringement and interest (including amounts for infringements before the Effective Date of this Agreement and any interest attributable thereto), or as a consequence of a judgment in any action (“Revenue”), the parties shall share equally all such revenue generated notwithstanding their respective ownership interests in the Patent as set forth in Section 2.1 above, with 50% of the proceeds for the account of TREBUCHET and 50% of the proceeds for the account of DSS, each to be distributed according the subparagraph 2.4(b) herein, except that, to the extent that a Court awards fees, expenses or other remuneration to either DSS or TREBUCHET or both as the case may be as the prevailing party or parties in any European Litigation, such fees and expenses shall be solely payable to and for the account of TREBUCHET. For all purposes of this Agreement, Revenue shall be calculated before, and without regard to, reduction of or be offset by, any expense incurred by either Party, including, but without limitation, any contingent legal or other fees expect as noted in the foregoing sentence.

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(b) Creation of Trust Account. Revenue shall be deposited into a Trust Account of TREBUCHET managed by a managing lawyer, or its designee, to be selected by TREBUCHET and such managing lawyer shall act at the instruction or direction of TREBUCHET (“Managing Lawyer”).

1)   The Parties agree that the Managing Lawyer will (and will be directed to) receive all Revenue from the European Litigation and will immediately place same into said Trust Account kept for that purpose. The Managing Lawyer will hold that part of the Revenue due DSS in the Trust Account and will dispense such Revenue due DSS to DSS at the direction of TREBUCHET. The Managing Lawyer will hold that part of the Revenue due under this Agreement to TREBUCHET in the Trust Account in trust for TREBUCHET and will dispense such Revenue due TREBUCHET to TREBUCHET in accordance with the directions of TREBUCHET.

2)   The Parties expect that funds held in the Trust Account will be dispensed simultaneously to each of the Parties. If DSS or TREBUCHET directly or indirectly receives any part of the Revenues due to the other Party, it shall immediately pay such Revenues over to the Managing Lawyer to be paid into the Trust Account and dealt with under the terms of this Agreement.

3)   TREBUCHET shall account to DSS for funds owed to DSS, to be paid at least once quarterly as long as there are funds in the Trust Account that can be paid over to DSS.

4)   TREBUCHET shall be entitled to use monies due TREBUCHET held in the Trust Account to meet its funding undertakings under this Agreement as provided in Section 2.2, but only after DSS has been paid its share of the Revenue due it.

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5)   Each Party shall pay its own taxes.

6)   Unless otherwise agreed by the Parties hereto in writing, monies in the Trust Account that have been received as a result of a decision by a national Court which awards royalties, damages, attorney fees or costs etc., shall not be distributed to either Party or to the Party to whom the money is due unless and until an appeal of any decision awarding such damages, attorney fees or costs is concluded and decided or the time for appeal has elapsed without appeal.

ARTICLE 3

FUTURE CLAIMS

In the event that the ECB or any other Person identified in Schedule 1 brings an invalidity action against the Patent or an action seeking a determination of non infringement with respect to the Patent subsequent to the Effective Date, TREBUCHET shall, in its sole discretion, undertake the defense of said action provided further that TREBUCHET is notified of the claim within twenty (20) business days of written notice to DSS. In the event that a validity proceeding is initiated by any Person not identified on Schedule 1 and /or a validity proceeding is brought in a European national state not listed in Schedule 9, TREBUCHET shall have the right but not the obligation to defend such proceedings and if elects to do so, it shall pay the expenses associated therewith.

ARTICLE 4

SECURITY INTEREST IN PATENT AND IN PROCEEDS

4.1 IN THE PATENT. In consideration of the funding undertakings and management of TREBUCHET, and to secure the payments to TREBUCHET set out in Article 2.4 herein, DSS hereby gives TREBUCHET a first priority security interest and/or lien in its 51% ownership interest in the Patent as of the Effective Date hereof. Such first priority security interest and/or lien in the Patent shall be recorded, as needed, by filing in the respective national European contracting states where the Patent is in force or where otherwise appropriate a confirmatory patent security agreement in the form necessary to comport with the filing requirements of each national European contracting state where the Patent is in force in which the security interest and/or lien may need to be officially recorded.TREBUCHET shall promptly reimburse DSS all actual, out-of-pocket expenses reasonably incurred by DSS in connection with it satisfying its obligations under this Section 4.1.

4.2 IN THE REVENUES. In consideration of the funding undertakings and management undertaken by TREBUCHET, DSS hereby gives TREBUCHET a first priority security interest and/or lien in any and all Revenues due DSS under Section 2.4 hereof and by virtue of any assertion of the Patent with respect to the Persons listed in Schedule 1, including, without limitation, any Revenues resulting out of any future or retroactive licenses or other agreements concerning payment of past damages under the Patent with one or more such Persons, to secure any indebtedness, obligations and liabilities of DSS to TREBUCHET which now exist or may hereinafter arise. The Parties will cooperate to record and perfect as soon as reasonably practical such security interest and/or lien as appropriate, and will promptly enter into a separate security agreement if necessary to accomplish same. TREBUCHET shall promptly reimburse DSS all actual, out-of-pocket expenses reasonably incurred by DSS in connection with it satisfying its obligations under this Section 4.2.

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4.3 CONSENTS. DSS has obtained all consents required in connection with the granting of the security interests described in Sections 4.1 and 4.2 hereof including, without limitation, the consents of Fagenson & Co., Inc. and Patrick White, as required under certain Credit Agreements between either of them and DSS, dated January 4, 2008.

4.4 DEFAULT. Upon, and only upon, any event that is determined by agreement or by tribunal of competent jurisdiction to entitle TREBUCHET to terminate this Agreement as provided hereinafter in Article 9(b)(a), 9(b)(b) or 9(b)(c), DSS shall assign all its remaining right, title, and interest in the Patent and TREBUCHET shall be entitled to take sole title in the Patent, including but not limited to the right to enforce the Patent in its sole name and generate revenue for all past and future infringements, along with the right to such revenue as herein otherwise provided. Within 10 business days of the Effective Date, DSS shall execute a document assigning and conveying all of its remaining right, title and interest in the Patent to TREBUCHET, which document shall be effective immediately prior to the event referred to herein (but not before) and which document shall be held in escrow pending such event by the Managing Attorney. Upon termination of this Agreement in accordance with any of Article 9 (b) (a)-(c) herein, TREBUCHET shall be entitled to record the document as may be required to perfect its sole title in the Patent. Notwithstanding the foregoing, DSS shall be entitled to its share of the Revenue as otherwise provided herein subject to any claim for damages held by TREBUCHET.

ARTICLE 5

INDEMNIFICATION

5.1 INDEMNIFICATION BY TREBUCHET. TREBUCHET shall promptly indemnify and hold DSS and each of its officers, directors, employees, shareholders and agents harmless for and pay any and all liabilities, damages, securities, penalties and all other monetary relief awarded to the ECB and to those Persons against whom assertions are made and/or who file invalidity and/or non-infringement suits, however characterized, whether actual or enhanced, and any awards of costs, expenses and attorneys’ fees, but only as long as same pertain to the European Litigation. For the purposes of clarification and notwithstanding the foregoing, TREBUCHET assumes no liability for any assertions of the Patent or for any invalidity suits unless same involve the ECB or the Persons contemplated herein. TREBUCHET further assumes no liability for any infringement actions or infringement claims asserted against DSS, nor will it defend DSS in connection with any such claims, irrespective of who brings such actions or claims unless such actions or claims are initiated as a direct result solely of actions of TREBUCHET or in the name of DSS by virtue of TREBUCHET’s rights granted in this Agreement.

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5.2 INDEMNIFICATION BY DSS. DSS shall promptly indemnify and hold TREBUCHET, and each of its officers, directors, employees, members and agents, harmless for and pay any and all liabilities, damages, securities, penalties and all other monetary relief from and against (including the reasonable costs of defending against) all claims, damages, liabilities as may arise from or out of its relationship with DSS including but not limited to any material misrepresentation of the representations and warranties contained in this Agreement including without limitation the schedules hereto and Article 6, except as to matters pertaining to the European Litigation arising from actions taken by TREBUCHET after the Effective Date; provided, however, that the provisions of this Section 5.2 shall not diminish TREBUCHET’s undertakings provided in this Agreement.

ARTICLE 6

REPRESENTATIONS AND WARRANTIES OF THE PARTIES TO EACH OTHER

6.1 REPRESENTATIONS AND WARRANTIES OF DSS. DSS represents and warrants to TREBUCHET that each of the following statements is true and correct as of the Effective Date:

a. Accuracy of Schedules. All Schedules and Exhibits to this Agreement, including, without limitation, Schedule 10, which provides the information of the European Litigation included in the PPM, are accurate, complete, and true in all material respects.

b. The entities listed in Schedule 1 are all of the Persons now known or deemed by DSS to, now or in the past, infringe or allegedly infringe the Patent. DSS does not have knowledge or reason to believe at this time that any other Persons are now infringing or have infringed the Patent.

c. Patent Validity. Except as set forth in the Schedule 10, the Patent is valid and subsisting, has not expired or lapsed, and has not been adjudicated invalid or unenforceable, in whole or in part. There is no decision adverse to DSS’ right to enforce the Patent and there is no proceeding involving such rights threatened or pending other than those set forth in Schedule 10.

d. Ownership of Patent. Except as specifically set forth in Schedule 11 and with respect to the assignment of a 49% interest in the Patent to TREBUCHET, as provided for in this Agreement, DSS is the sole and exclusive owner of the entire and unencumbered right, title and interest on and to the Patent, free and clear of any liens, charges and encumbrances, including without limitation licenses, immunities, privileges, pledges, claims, attachments, shop rights and covenants by DSS not to sue third persons, and to the best knowledge of DSS, none of the proprietary rights is subject of any claim in any applicable jurisdiction. DSS has the sole right to mortgage, pledge and assign the Patent and the sole and exclusive right to grant the assignment and security interest and liens granted herein. There is no decision adverse to DSS’ claim of ownership or claim of exclusive right to the Patent or DSS’ right to enforce the Patent, and there is no proceeding involving such rights threatened or pending. DSS has provided TREBUCHET with a copy of any and all opinions and other writings prepared by MWE concerning the ownership issues of the Patent which were identified in MWE’s retainer letter dated 2004, and if none are available, has otherwise disclosed the results of that undertaking and engagement to TREBUCHET.

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e. European Law. European counsel identified in Schedule 12 have been made aware of the fact that the European Litigation will be funded, managed and controlled by TREBUCHET, and that TREBUCHET shall share in the proceeds of any Revenue generated from assertions of the Patent as, inter alia., an owner of the Patent, and DSS represents and warrants that such European counsel, and each of them, have advised DSS that they know of no reason why, under the law of their respective applicable jurisdiction, TREBUCHET cannot so fund, manage and control the European Litigation and cannot share in the proceeds of any revenue generated from assertions of the Patent, and TREBUCHET, in doing so, will not run afoul of any European or national legislation, rules or practices that will have a material adverse effect on TREBUCHET.

f. Organization, Standing and Power. Each of DSS and its Subsidiaries (all of which are listed on Schedule 4) is a corporation or limited liability company duly organized, validly existing and in good standing, and no certificates of dissolution have been filed under the laws of its jurisdiction of organization. Each of DSS and its Subsidiaries has the power to own its properties and to carry on its business as now being conducted and as presently proposed to be conducted and is duly authorized and qualified to do business and is in good standing in each jurisdiction in which the failure to be so qualified and in good standing would have a Material Adverse Effect on DSS. Unless such have been filed as exhibits in the SEC Reports available on the SEC’s EDGAR system, DSS has delivered or made available to TREBUCHET a true and correct copy of its Certificate of Incorporation and By-laws, each as amended to date. DSS is not in violation of any of the provisions of its Certificate of Incorporation or By-laws. DSS is the direct or indirect owner of all outstanding shares of capital stock of each of its Subsidiaries and all such shares are duly authorized, validly issued, fully paid and nonassessable. All of the outstanding shares of capital stock of each such Subsidiary are owned by DSS free and clear of all liens, charges, claims or encumbrances or rights of others, other than a security interest in the common stock of Plastic Printing Professionals, Inc. in favor of Fagenson & Co., Inc., as agent, pursuant to that certain Credit Agreement, dated January 4, 2008, between Fagenson & Co., Inc. and DSS.

g. Authority; Binding Nature of Agreement. DSS has all necessary corporate power and authority to enter into and to perform its obligations under this Agreement and the other Transaction Documents, and the execution, delivery and performance by DSS of the Transaction Documents have been duly authorized by all necessary action on the part of DSS and its board of directors and stockholders, as applicable. Each of the Transaction Documents to which DSS is a party constitutes the legal, valid and binding obligation of DSS, enforceable against DSS in accordance with its terms, subject to: (i) laws of general application relating to bankruptcy, insolvency and the relief of debtors; and (ii) rules of law governing specific performance, injunctive relief and other equitable remedies.

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h. SEC Reports; Financial Statements. DSS has filed all reports required to be filed by it under the Securities Act and the Exchange Act, including pursuant to Section 13(a) or 15(d) thereof (the foregoing materials being collectively referred to herein as the “SEC Reports”) on a timely basis or has received a valid extension of such time of filing and has filed any such SEC Reports prior to the expiration of any such extension. DSS has delivered or otherwise made available to TREBUCHET via the EDGAR website copies of all SEC Reports filed within the 10 days preceding the date hereof. Except as set forth in Schedule 13, as of their respective dates, the SEC Reports complied in all material respects with the requirements of the Securities Act and the Exchange Act and the rules and regulations of the Commission promulgated thereunder, and none of the SEC Reports, when filed, contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. Except as set forth in Schedule 13, the financial statements of DSS included in the SEC Reports (the “Financial Statements”) comply in all material respects with applicable accounting requirements and the rules and regulations of the Commission with respect thereto as in effect at the time of filing. The Financial Statements have been prepared in accordance with GAAP, except as may be otherwise specified in the Financial Statements or the notes thereto, and fairly present in all material respects the assets, liabilities, financial position and results of operations of DSS as of and for the dates thereof and the results of operations and cash flows for the periods then ended, subject, in the case of unaudited statements, to normal, immaterial, year-end audit adjustments. The books and records of DSS are true, accurate and complete in all material respects. All material agreements to which DSS is a party or to which the property or assets of DSS are subject are included as part of or specifically identified in the SEC Reports.

i. Binding Agreement. This Agreement is legal, valid, and binding upon the DSS, enforceable against DSS in accordance with its terms, except to the extent limited by bankruptcy, insolvency, moratorium, and other laws of general application relating to or affecting the enforcement of creditors’ rights and general equity principles.

j. Compliance with Applicable Laws.DSS has maintained the Patent in compliance with all Applicable Laws. DSS has never received any notice or other communication from any person regarding any actual or possible violation of, or failure to comply with, any Applicable Laws with respect to the Patent. DSS has obtained all material permits, certificates and licenses required by any Applicable Laws for the conduct of its business and the ownership of its assets. DSS is not in violation of any such permit, certificate or license, and no legal proceedings or other actions are pending or, to the knowledge of DSS, threatened to revoke or limit any such permit, certificate or license. DSS has maintained the Patent in force and paid all Annuities due on the Patent through the date of this Agreement.

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k. Conflict with Other Agreements. The execution, delivery, and performance of this Agreement does not conflict with, constitute a default under, or violate any provision of (i) the Certificate of Incorporation of DSS, (ii) the By-laws of DSS, or (iii) any instrument or agreement to which DSS is a party or under which DSS or any Patent is bound. DSS further warrants that no award, citation, code, decree, edict, injunction, judgment, law, order, ordinance, rule, regulation, or writ or including but not limited to, those of federal, state and local governments, agencies of those governments, courts or arbitration panels, have been issued or are now pending against DSS or the Patent that would prohibit the consummation of this transaction. DSS will not execute or otherwise enter into any agreement in conflict with the rights granted to TREBUCHET under this Agreement without TREBUCHET’S prior written permission.

l. Consideration for Assignment and Security Interest in /Lien on Patent. The consideration to be delivered to DSS for the conveyance of an interest in the Patent and a security interest in and/or lien on its remaining interest in the Patent pursuant to this Agreement constitutes reasonably equivalent value for TREBUCHET’s undertakings set forth in this Agreement. DSS has not been sued or threatened with suit by any creditor before the execution of this Agreement, and DSS has not concealed the Patent from any of its creditors.

m. Contracts. There are no existing Contracts between DSS and any third party that (a) affect the Patent, other than as disclosed in Schedule 11, or (b) will bind or obligate TREBUCHET.

n. Disclosure. No representation or warranty made by DSS in this Agreement, nor any statement or certificate furnished or to be furnished to TREBUCHET pursuant hereto or in connection with the transactions contemplated hereby, contains or shall contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements contained herein or therein not misleading.

o. Liabilities.DSS has no material commitments, indebtedness, liabilities, or obligations of any nature, whether absolute or contingent (“Liabilities”), except for (i) Liabilities reflected on the Financial Statements, (ii) accounts payable incurred in the ordinary course of business since the date of the last balance sheet reflected in the Financial Statements, (iii) Liabilities under any contracts, (iv) Liabilities incurred in connection with the negotiation of the Transaction Documents and the transactions contemplated thereby and (v) liabilities incurred in the ordinary course of business. In addition, DSS does not have any Liabilities that would adversely impact the transactions contemplated under this Agreement or any of the other Transaction Documents.

p. Litigation. Other than as set forth in the SEC Reports or on any of the Schedules to this Agreement, DSS has no knowledge of any claims, actions, suits, proceedings, arbitrations, or investigations, pending or threatened, in any court, arbitration panel, Governmental Agency, or otherwise, against, by or affecting the Patent, or which would prevent the performance of this Agreement or any of the transactions contemplated hereby or declare the same unlawful or cause the rescission thereof.

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q. Taxes. DSS has, in the past, properly prepared in all material respects and has filed, all federal, state, local and other tax returns and reports required to be filed pursuant to all applicable laws, regulations, and statutes; DSS is not a party to any action for collection of taxes; DSS does not know of any grounds supporting any contemplated action concerning same.

r. Non-Infringement. The technology disclosed in the Patent does not interfere with, infringe upon, misappropriate, or violate any material intellectual property right or rights (including, without limitation, patent, trademark, trade dress, trade secrets or copyright) of any third party.

s.No Contravention. Neither the execution and the delivery of this Agreement, nor the consummation of the transactions contemplated hereby will (i) violate any constitution, statute, regulation, rule, injunction, judgment, order, decree, ruling, charge, or other restriction of any government, governmental agency, or court to which DSS is subject or any provision of its charter or bylaws or (ii) conflict with, result in a breach of, constitute a default under, result in the acceleration of, create in any party the right to accelerate, terminate, modify, or cancel, or require any notice under any agreement, contract, lease, license, instrument, or other arrangement to which DSS is a party or by which it is bound or to which it Patent is subject.

t. Funding.Schedule 8 lists all current pending and proposed actions and provides an informed estimate of the future costs and expenses which TREBUCHET may incur as a consequence of any undertakings it determines to take with respect to the European Litigation. DSS warrants and represents that Schedule 8 is accurate and complete. DSS acknowledges that TREBUCHET has entered into this Agreement with the understanding that its costs and expenses will not in any case unreasonably exceed the estimates provided in said Schedule. DSS further acknowledges that TREBUCHET’S ability to raise capital is premised on the accuracy and completeness of disclosures made in Schedule 8.

u. Broker. Neither DSS nor any entity directly or indirectly controlling DSS has incurred any liability or obligation to any agent, broker, or finder for any brokerage fees, commissions, finder’s fees, or other compensation with respect to the transactions contemplated by this Agreement. DSS acknowledges that the services performed by Robert Girards, individually, do not constitute the acts of an agent, broker, or finder for the purposes of this Agreement.

6.2 REPRESENTATIONS AND WARRANTIES OF TREBUCHET. TREBUCHET represents and warrants to DSS that each of the following statements is true and correct as of the Effective Date:

a. TREBUCHET represents and warrants that it shall comply with the undertakings of Article 3. If TREBUCHET does not pay, or arrange for any payment, as required under Article 3 above, or otherwise satisfy on time and in full its undertakings with respect to the European Litigation, if DSS shall have such funds available to it on terms that are reasonable in the sole discretion of DSS, then DSS promptly shall pay to ECB or any other Person the full amount required under Article 3 above which remains outstanding on such date. Such payment by DSS shall not limit the undertakings of TREBUCHET set forth above in Article 3 and, to the extent DSS pays any money or other damages to ECB or any other Person pursuant to this Article 3, TREBUCHET immediately shall reimburse DSS therefore. DSS shall also be entitled to recover from TREBUCHET interest on any unpaid principal balance from the date due until the date paid at the lesser of ten percent (10%) per year or the maximum rate permitted by law.

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LIMITATION OF LIABILITY. THE FOREGOING STATES TREBUCHET’S ENTIRE LIABILITY TO DSS ARISING OUT OF OR RELATED TO THE EUROPEAN LITIGATION. IN NO EVENT SHALL TREBUCHET BE LIABLE TO DSS FOR ANY INDIRECT, SPECIAL, INCIDENTAL, CONSEQUENTIAL OR PUNITIVE DAMAGES ARISING OUT OF OR RELATED TO ANY BREACH OF THIS AGREEMENT; PROVIDED, THAT THIS LIMITATION SHALL NOT LIMIT TREBUCHET’S UNDERTAKINGS EXPRESSLY ASSUMED IN THIS AGREEMENT. NOR SHALL TREBUCHET BE LIABLE FOR ANY CLAIMS BY DSS THAT IT MISMANAGED THE EUROPEAN LITIGATION, OR THAT ITS ACTIONS OR NON-ACTIONS RESULTED NEGLIGENTLY IN A LOSS OF PATENT RIGHTS.

b. Authority; Binding Nature of Agreement. TREBUCHET has all necessary corporate power and authority to enter into and to perform its undertakings under this Agreement and the other Transaction Documents, and the execution, delivery and performance by TREBUCHET of the Transaction Documents have been duly authorized by all necessary action on the part of TREBUCHET and its Managing Member, as applicable. Each of the Transaction Documents to which TREBUCHET is a party constitutes the legal, valid and binding obligation of TREBUCHET, enforceable against TREBUCHET in accordance with its terms, subject to: (i) laws of general application relating to bankruptcy, insolvency and the relief of debtors; and (ii) rules of law governing specific performance, injunctive relief and other equitable remedies.

c. Binding Agreement. This Agreement is legal, valid, and binding upon the DSS, enforceable against TREBUCHET in accordance with its terms, except to the extent limited by bankruptcy, insolvency, moratorium, and other laws of general application relating to or affecting the enforcement of creditors’ rights and general equity principles.

d Conflict with Other Agreements. The execution, delivery, and performance of this Agreement does not conflict with, constitute a default under, or violate any provision of the articles of organization of TREBUCHET or any instrument or agreement to which TREBUCHET is a party or under which TREBUCHET is bound. TREBUCHET further warrants that no award, citation, code, decree, edict, injunction, judgment, law, order, ordinance, rule, regulation, or writ or including but not limited to, those of federal, state and local governments, agencies of those governments, courts or arbitration panels, have been issued or are now pending against TREBUCHET that would prohibit the consummation of this transaction. TREBUCHET will not execute or otherwise enter into any agreement in conflict with the rights granted to DSS under this Agreement without DSS’ prior written permission.

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e. Disclosure. No representation or warranty made by TREBUCHET in this Agreement, nor any statement or certificate furnished or to be furnished to DSS pursuant hereto or in connection with the transactions contemplated hereby, contains or shall contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements contained herein or therein not misleading.

f. No Contravention. Neither the execution and the delivery of this Agreement, nor the consummation of the transactions contemplated hereby (including the Assignment and Assumption referred to in Section 1.2 above), will (i) violate any constitution, statute, regulation, rule, injunction, judgment, order, decree, ruling, charge, or other restriction of any government, governmental agency, or court to which DSS is subject or any provision of its charter or bylaws or (ii) conflict with, result in a breach of, constitute a default under, result in the acceleration of, create in any party the right to accelerate, terminate, modify, or cancel, or require any notice under any agreement, contract, lease, license, instrument, or other arrangement to which DSS is a party or by which it is bound or to which it Patent is subject.

g. Broker. Neither TREBUCHET nor any entity directly or indirectly controlling TREBUCHET has incurred any liability or obligation to any agent, broker, or finder for any brokerage fees, commissions, finder’s fees, or other compensation with respect to the transactions contemplated by this Agreement. TREBUCHET acknowledges that the services performed by Robert Girards, individually, do not constitute the acts of an agent, broker, or finder for the purposes of this Agreement.

ARTICLE 7

EXCLUSIONS; OTHER OBLIGATIONS

OBLIGATIONS TO THIRD PARTY LICENSEES. Notwithstanding its ownership interest in the Patent, TREBUCHET assumes no responsibility for obligations to Third Party Licensees under any Third Party License Agreements which it may enter into with respect of the Patent, whether such agreements be entered in settlement of the European Litigation or otherwise, other than those obligations specifically assumed by TREBUCHET in this Agreement, including, by way of example and without limitation, any obligations of DSS to, at DSS’ expense, indemnify such licensees for any third party infringement claims and to provide infringement remedies, such as providing non-infringing substitute products, conducting product recalls, modifying current products to avoid further infringement or procuring applicable licenses, all as my be set forth in such Third Party License Agreements.

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ARTICLE 8

CONFIDENTIALITY

The terms of the Confidential Disclosure Agreement between the parties shall apply to any Confidential Information (as defined therein) that pertains to this Agreement.

ARTICLE 9

TERMINATION

(a)This Agreement shall remain in full force and effect unless and until terminated by a mutual written agreement of the parties. Each Party acknowledges and agrees that its remedy for breach by the other Party of this Agreement shall be, subject to the requirements of Article 10, to bring a claim to recover damages subject to the limitations of this Agreement and to seek any appropriate equitable relief, other than the termination of this Agreement.

(b)TREBUCHET shall have the right to terminate this Agreement and all of its undertakings of the Agreement effective immediately upon written notice to DSS:

a) in the event that DSS shall i) apply for or consent to the appointment of, or the taking of possession by, a receiver, custodian, trustee or liquidator of itself or of all or a substantial part of its property or assets, (ii) make a general assignment for the benefit of its creditors, (iii) commence a voluntary case under the United States Bankruptcy Code (as now or hereafter in effect) or under the comparable laws of any jurisdiction (foreign or domestic), (iv) file a petition seeking to take advantage of any bankruptcy, insolvency, moratorium, reorganization or other similar law affecting the enforcement of creditors’ rights generally, (v) acquiesce in writing to any petition filed against it in an involuntary case under United States Bankruptcy Code (as now or hereafter in effect) or under the comparable laws of any jurisdiction (foreign or domestic), (vi) issue a notice of bankruptcy or winding down of its operations or issue a press release announcing same, or (vii) take any action under the laws of any jurisdiction (foreign or domestic) analogous to any of the foregoing; or

b)in the event that a proceeding or case shall be commenced in respect of DSS, without its application or consent, in any court of competent jurisdiction, seeking (i) the liquidation, reorganization, moratorium, dissolution, winding up, or composition or readjustment of its debts, (ii) the appointment of a trustee, receiver, custodian, liquidator or the like of it or of all or any substantial part of its assets in connection with the liquidation or dissolution of DSS or (iii) similar relief in respect of it under any law providing for the relief of debtors, and such proceeding or case described in clause (i), (ii) or (iii) shall continue undismissed, or unstayed and in effect, for a period of thirty (30) days or any order for relief shall be entered in an involuntary case under United States Bankruptcy Code (as now or hereafter in effect) or under the comparable laws of any jurisdiction (foreign or domestic) against DSS or action under the laws of any jurisdiction (foreign or domestic) analogous to any of the foregoing shall be taken with respect to DSS and shall continue undismissed, or unstayed and in effect for a period of thirty (30) days; or

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c) in the event of a Material Adverse Effect as that term is defined herein; or

d) in the event of a material misrepresentation of the representations and warranties of DSS contained in this Agreement including without limitation the schedules hereto and Article 6 above and such misrepresentation has adversely affected the rights of TREBUCHET under the Agreement; or

e) *

f) in the event that the Patent is not held valid after exhausting appeals in at least one national contracting state of the European Union in which national contracting state infringement proceedings can be brought against a Person or Persons identified in Schedule 1.

Notwithstanding any such termination for the reasons provided hereinabove (a) - (e), or any Dispute as that term is defined in Article 10 below arises, TREBUCHET shall retain and maintain its equity interest in the Patent as an owner and be entitled to any benefits to be derived as such including but not limited to the right to any recoveries for past infringement, provided however that TREBUCHET’s rights and interest following termination shall not exceed in scope or nature its rights or interest prior to termination. Notwithstanding its right to do so, in the case of a bankruptcy of DSS, TREBUCHET may elect to retain its exclusivity in the intellectual property rights of DSS herein conveyed as provided in 11 U.S.C. Section 365(n), providing however that TREBUCHET shall continue to account and pay over to DSS revenue generated from the activities related to the European Litigation and the Patent, including but not limited to royalties, as specifically provided hereinabove in subparagraph 2.4. Nothing in this Article 9 shall entitle TREBUCHET the right to reimbursement from DSS of costs incurred by TREBUCHET pursuant to this Agreement, including, without limitation, Section 2.2(d)(2) hereof.

ARTICLE 10

DISPUTE RESOLUTION

10.1 MEDIATION. If a dispute, controversy or claim (“Dispute”) arises between the parties relating to the interpretation or performance of this Agreement, appropriate senior executives (e.g. director or vice president level) of each Party who shall have the authority to resolve the matter shall meet to attempt in good faith to negotiate a resolution of the Dispute prior to pursuing other available remedies. The initial meeting between the appropriate senior executives shall be referred to herein as the “Dispute Resolution Commencement Date.” Discussions and correspondence relating to trying to resolve such Dispute shall be treated as confidential information developed for the purpose of settlement and shall be exempt from discovery or production and shall not be admissible in any proceeding concerning the Dispute. If the senior executives are unable to resolve the Dispute within thirty (30) days from the Dispute Resolution Commencement Date, and either Party wishes to pursue its rights relating to such Dispute, then the Dispute will be mediated by a mutually acceptable mediator appointed pursuant to the mediation rules of JAMS/Endispute within thirty (30) days after written notice by one Party to the other demanding non-binding mediation. Neither Party may unreasonably withhold consent to the selection of a mediator or the location of the mediation. Both parties will share the costs of the mediation equally, except that each Party shall bear its own costs and expenses, including attorney’s fees, witness fees, travel expenses, and preparation costs. The parties may also agree to replace mediation with some other form of non-binding or binding Alternative Dispute Resolution (“ADR”).

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10.2 ARBITRATION. Any Dispute which the parties cannot resolve through mediation within ninety (90) days of the Dispute Resolution Commencement Date, unless otherwise mutually agreed, shall be submitted to final and binding arbitration under the then current Commercial Arbitration Rules of the American Arbitration Association (“AAA”), by three (3) arbitrators in New York City, New York. Such arbitrators shall be selected by the mutual agreement of the parties or, failing such agreement, shall be selected according to the aforesaid AAA rules. The arbitrators will be instructed to prepare and deliver a written, reasoned opinion stating their decision within thirty (30) days of the completion of the arbitration. The prevailing Party in such arbitration shall be entitled to expenses, including costs and reasonable attorneys’ and other professional fees, incurred in connection with the arbitration (but excluding any costs and fees associated with prior negotiation or mediation). The decision of the arbitrator shall be final and non-appealable and may be enforced in any court of competent jurisdiction. The use of any ADR procedures will not be construed under the doctrine of laches, waiver or estoppel to adversely affect the rights of either Party.

10.3 COURT ACTION. Any Dispute regarding the following is not required to be negotiated, mediated or arbitrated prior to seeking relief from a court of competent jurisdiction: breach of any obligation of confidentiality; infringement, misappropriation, or misuse of any intellectual property right owned by one Party by the other Party; any other claim where interim relief from the court is sought to prevent serious and irreparable injury to one of the parties or to others. However, the parties to the Dispute shall make a good faith effort to negotiate and mediate such Dispute, according to the above procedures, while such court action is pending.

10.4 CONTINUITY OF PERFORMANCE. Unless otherwise mutually agreed in writing, the parties will continue to honor all other commitments under this Agreement and related agreements during the course of any dispute.

ARTICLE 11

MISCELLANEOUS PROVISIONS

11.1 ENTIRE AGREEMENT. This Agreement constitutes the entire agreement between the parties with respect to the European Litigation and supersedes all terms in any other prior written and oral and all contemporaneous oral agreements and understandings with respect to the European Litigation.

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11.2 GOVERNING LAW. This Agreement shall be construed in accordance with and all Disputes hereunder shall be governed by the laws of the State of New York, excluding its conflict of law rules. The Supreme Court of the State of New York and/or the United States District Court for the Southern District of New York shall have jurisdiction and venue over all Disputes between the parties that are permitted to be brought in a court of law pursuant to Article 10 above.

11.3 DESCRIPTIVE HEADINGS. The headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. When a reference is made in this Agreement to an Article or a Section, such reference shall be to an Article or Section of this Agreement unless otherwise indicated.

11.4 NOTICES. Notices, offers, requests or other communications required or permitted to be given by either Party pursuant to the terms of this Agreement shall be given in writing to the respective parties to the following addresses:

If to TREBUCHET:

Trebuchet Capital Partners, LLC

609-3 Cantiague Rock Road

Westbury, New York 11590

Attention: Managing Member

With a copy to:

Trebuchet Capital Partners, LLC

PO Box 7866

Hicksville, New York 11802-7866

 If to DSS:

Document Security Systems, Inc.

28 East Main Street

Suite 1525

Rochester, NY 14614

Attention: Chief Executive Officer

or to such other address as the Party to whom notice is given may have previously furnished to the other in writing as provided herein. Any notice involving non-performance, termination, or renewal shall be sent by hand delivery, recognized overnight courier or, within the United States, may also be sent via certified mail, return receipt requested. All other notices may also be sent by fax, confirmed by first class mail. All notices shall be deemed to have been given and received on the earlier of actual delivery or three (3) days from the date of postmark.

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11.5 NONASSIGNABILITY. Neither Party may, directly or indirectly, in whole or in part, whether by operation of law or otherwise, assign or transfer this Agreement without the other Party’s prior written consent, and any attempted assignment, transfer or delegation without such prior written consent shall be voidable at the sole option of such other Party. Without limiting the foregoing, this Agreement will be binding upon and inure to the benefit of the Parties and their permitted successors and assigns, including any person that becomes party to this Agreement by reason of merger, consolidation or sale of substantially all of the assets or business of DSS.

11.6 SEVERABILITY. If any term or other provision of this Agreement is determined by a court, administrative agency or arbitrator to be invalid, illegal or incapable of being enforced by any rule of law or public policy, all other conditions and provisions of this Agreement shall nevertheless remain in full force and effect so long as the economic or legal substance of the transactions contemplated hereby is not affected in any manner materially adverse to either Party. Upon such determination that any term or other provision is invalid, illegal or incapable of being enforced, the parties hereto shall negotiate in good faith to modify this Agreement so as to effect the original intent of the parties as closely as possible in an acceptable manner to the end that transactions contemplated hereby are fulfilled to the fullest extent possible.

11.7 FAILURE OR INDULGENCE NOT WAIVER; REMEDIES CUMULATIVE. No failure or delay on the part of either Party hereto in the exercise of any right hereunder shall impair such right or be construed to be a waiver of, or acquiescence in, any breach of any representation, warranty or agreement herein, nor shall any single or partial exercise of any such right preclude other or further exercise thereof or of any other right. All rights and remedies existing under this Agreement or the Schedules attached hereto are cumulative to, and not exclusive of, any rights or remedies otherwise available.

11.8 AMENDMENT. No change or amendment will be made to this Agreement except by an instrument in writing signed on behalf of each of the parties to such agreement.

11.9 COUNTERPARTS. This Agreement may be executed in counterparts, each of which shall be deemed to be an original but all of which shall constitute one and the same agreement.

WHEREFORE, the parties have signed this Agreement effective as of the Effective Date.

Trebuchet Capital Partners, LLC		Document Security Systems, Inc.
By:	/s/ Robert T. Girards	By:	/s/ Patrick White
Name:	Robert T. Girards	Name:	Patrick White
Title:	Manager	Title:	Chief Executive Officer

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SCHEDULE 1

ECB in Germany

Bundesbank in Germany

Bundesdruckerei in Germany

Giesecke & Devrient in Germany

ECB in France if DSS is successful at appeal

Banque de France if DSS is successful at appeal

François-Charles Oberthur Fiduciaire, French Security Printers if DSS is successful at appeal

ECB in the Netherlands

De Nederlandsche Bank

Joh. Enschedé the Dutch security printers

ECB in Spain

Banco de España

Fábrica Nacional de Moneda y Timbre, the Spanish security printers

ECB in Austria

Österreichische Nationalbank

Österreichische Banknoten und Sicherheitsdruck the Austrian security printers

Jura, the Austrian Hungarian document security software company

ECB in Belgium

Nationale Bank van België/Banque Nationale de Belgique

Agfa the Belgian document security software company

ECB in Italy

Banca d’Italia

Istituto Poligrafico e Zecca dello Stato the Italian security printers

ECB in Luxembourg

Banque centrale du Luxembourg

Orell Füssli Security Printing Ltd the Swiss security printers

Danish National Bank and security printers

Swedish National Bank and security printers

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SCHEDULE 2

United Kingdom: First instance and appeal, both lost to ECB

France: First instance lost to ECB, DSS appealed

Germany: First instance DSS won, ECB appealing

The Netherlands: First instance DSS won, ECB appealing

Spain: First instance trial is complete; awaiting judgment, which is expected in the second half of 2008

Italy: First instance trial is expected in the first half of 2009

Austria: First instance trial is expected in the first half of 2009

Belgium: First instance trial is expected in February 2009

Luxembourg: ECB twice filed in the wrong court; *.

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SCHEDULE 3

DSS has technically commenced assertion against the ECB in Belgium, with such action currently stayed during validity proceedings

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SCHEDULE 4

Document Security Consultants, Inc. (New York) (100% owned)

Thomas M. Wicker Enterprises, Inc. (New York) (100% owned)

Lester Levin, Inc. (New York) (100% owned)

Secured Document Systems, Inc. (New York) (100% owned)

Plastic Printing Professionals, Inc. (New York) (100% owned)

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SCHEDULE 5

Country	Patent Number
Europe	455750
Austria	455750
Belgium	455750
Switzerland	455750
Germany	69033363
Denmark	455750
Spain	455750
France (Currently Revoked)	455750
United Kingdom (Currently Revoked)	455750
Italy	455750
Liechtenstein	455750
Luxembourg	455750
Netherlands	455750
Sweden	455750

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SCHEDULE 6

*

31

SCHEDULE 7

*

32

SCHEDULE 8

*

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SCHEDULE 9

United Kingdom

Luxembourg

Netherlands

Belgium

Italy

France

Spain

Germany

Austria.

Switzerland

Sweeden

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SCHEDULE 10

Summary of European Litigation

Explanatory Note

Although we refer to the DSS Patent as one patent, there is no single patent that covers the entire European continent. When granted, a European patent is actually a collection of individual national patents, each of which is limited in its coverage to the relevant national jurisdiction. National courts have exclusive jurisdiction to determine the validity of national patents. The coverage of any European patent is determined by the states of the European Patent Convention (“EPC”) that are designated by the applicant prior to grant. Because these are national rights, there is no single court, even at the appeal levels, that can rule in respect of the entire European continent.

The law of each of the signatory states to the EPC is built on the same foundations governed by the EPC itself. For example, the provisions of novelty, inventive step, insufficiency, added subject matter and claim construction are laid out in the EPC. However, national courts can (and do) differ in their interpretation and application of these laws. There are also “optional” provisions (e.g. compulsory licensing) which differ between jurisdictions and substantive procedural differences (e.g. whether exclusive licensees can sue).

Since the underlying principles are the same, most national courts will consider decisions rendered by other national courts relating to the same patent. The amount and type of consideration given to earlier decisions differs between jurisdictions. However, earlier decisions are not binding in any way on actions brought in other jurisdictions.

Infringement Claim brought by DSSI in Luxembourg

On August 1, 2005, DSS commenced a lawsuit against the European Central Bank (“ECB”) in the European Court of First Instance in Luxembourg (the “European Court of First Instance”) alleging infringement by the ECB of the DSS Patent. In its complaint DSS claimed that the ECB was circulating Euro banknotes incorporating certain anti-counterfeiting technology, which protects against forgeries by digital scanning and copying devices, and that the use of such technology infringes the DSS Patent. On September 5, 2007, the European Court of First Instance informed the parties that it did not have jurisdiction to rule on this patent infringement claim. Additionally, the European Court of First Instance instructed DSS to pay the ECB’s attorneys’ fees and court fees with respect to such suit. The ECB hasformally requested DSS to pay attorneys fees and court fees in the aggregate amount of €93,752 (US$137,815 based on the applicable exchange rate on August 15, 2008). If DSS does not pay that amount or if DSS contests the amount payable, this will be subject to an assessment procedure that will not likely be concluded prior to the end of this year. DSS has disclosed this amount as a contingent liability but will not record it until the actual amount is known upon final assessment.

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Patent Invalidity Challenges

On March 24, 2006, DSS was served with notice that the ECB filed separate claims in the United Kingdom and Luxembourg courts seeking the invalidation of the DSS Patent. Proceedings were commenced before the national courts seeking revocation and declarations ofinvalidity of the DSS Patent in each of the Netherlands, Belgium, Italy, France, Spain, Germany and Austria.

Invalidity Challenge by the ECB in the United Kingdom

On March 26, 2007, the High Court of Justice, Chancery Division, Patents Court in London, England (the “English Court”) ruled that the DSS Patent was invalid in the United Kingdom. The English High Court rejected the ECB’s allegations of invalidity based on lack of novelty, lack of inventive step and insufficiency, but held that the patent was invalid for added subject matter. That is, the English Court determined that language added to a patent claim at the appellate level of registration was not supported by the earlier disclosure in the specification and therefore was deemed “new matter,” rendering the patent invalid. Pursuant to the English Court’s decision, on March 30, 2007, the English Court awarded the ECB 30% of their costs (including legal fees) of the proceedings before the High Court. On April 19, 2007, DSS paid the ECB £90,000 (US$182,000 based on the applicable exchange rate on that date). DSS anticipates that it will be required to pay an additional approximately £90,000 (US$168,300 based on the applicable exchange rate on August 15, 2008) to reimburse the ECB for costs incurred by it in the English High Court proceedings. If the amount payable by DSS is not agreed, then the amount will be determined by separate assessment proceedings that can take up to about one year to complete.

In July 2007, the Company also posted a bond in the amount of £87,500 (US$177,000 based on the applicable exchange rate on that date), as collateral for the payment of any costs payable to the ECB in connection with DSS’s appeal of the English High Court decision. On March 19, 2008, the decision of the English High Court, including the award of the ECB’s costs,was upheld by the English Court of Appeal on appeal. The English Court of Appeal also ordered DSS to pay the ECB’s costs of the English appeal proceedings (including legal fees).

On June 19, 2008, the Company paid £87,500 ($177,000 based on the applicable exchange rate on that date) towards the ECB’s costs of the English appeal The ECB has informally quantified its total costs of the appeal to be €271,635.02 (US$399,303 based on the applicable exchange rate on August 15, 2008). In such circumstances, a paying party would normally expect to pay from 66% to 75% (€181,089 to €203,726 (US$266,201 to US$299,407 based on the applicable exchange rate on August 15, 2008)) of the total costs incurred. Unless the amounts are agreed by the parties, they will be subject to an assessment procedure that will not likely be concluded earlier than the first quarter of 2009.

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The costs (including legal fees) of the assessment procedure are normally paid by the party from whom costs are due. Interest normally accrues at 8% per annum simple rate on unpaid costs from the date of the order giving rise to the payment (i.e. March 30, 2007 in respect of High Court proceedings, March 19, 2008 in respect of appeal costs).

The determination of invalidity of the DSS Patent by the English Court does not determine the validity of the DSS Patent in other European countries.

Invalidity Challenge by the ECB in Germany

On March 27, 2007 the Bundespatentgericht of the Federal Republic of Germany ruled that the DSS Patent was valid. The court considered the English Court’s decision but, unlike the English Court, determined that the added language in the claim was supported by the specification. As a result of this ruling, DSS expects to be awarded its costs in an amount of €44,692 (US$65,697 based on the applicable exchange rate on August 15, 2008. On September 3, 2007 the ECB filed an appeal in the German Federal Supreme Court in an attempt to reverse the decision of the Bundespatentgericht. The results of this appeal are not expected until 2010.

Invalidity Challenge by the ECB in France

On January 9, 2008 the Tribunal de Grande Instance de Paris(the “French Court”) held that the DSS Patent was invalid in France, based on the same reasoning as the English Court relating to the added subject matter. The French Court did not make any findings on any other aspects of the case. The French Court awarded the ECB attorneys’ fees of less than $3,000 with respect to the invalidity action filed with the French Court. On May 7, 2008, DSS filed an appeal of the French Court decision. A decision on this appeal is expected in or around August 2009.

Invalidity Challenge by the ECB in the Netherlands

On March 12, 2008 the District Court of the Hague (the “Dutch Court”), having considered the decisions of the English Court, the German Court and the French Court ruled that the DSS Patent is valid in the Netherlands. The ECB filed an appeal of the Dutch Court decision on March 27, 2008. A decision on this appeal is not expected until in or around August 2009.

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Invalidity Challenge by the ECB in Luxembourg

The ECB has twice withdrawn its case in Luxembourg due to procedural irregularities. On the second occasion, the Court awarded DSS €1,000 in compensation for costs incurred in withdrawal of the suit. There are currently no proceedings in Luxembourg.

Invalidity Challenge by the ECB in Spain

The Commercial Court of Madrid (“the Spanish Court”) ordered, in accordance with mandatory procedure, that a report be prepared and submitted by an examiner of the Spanish Patent Office. That report was filed and recorded the examiner’s opinion that the DSS Patent was invalid for lack of inventive step. The examiner’s opinion did not address any other alleged ground of invalidity, including on the ground of “added matter,” which was the grounds cited by the English Court and the France Court in their determination of invalidity of the DSS Patent. A validity trial was held in the Spanish Court in early June 2008 with final oral and written arguments made in July 2008. The Spanish Court’s decision on the validity of the DSS Patent is expected in the second half of 2008.

Invalidity Challenge by the ECB in Austria

Administrative proceedings for the revocation of the DSS Patent were commenced by the ECB in the Austrian Patent Office. Each of the parties has filed several written briefs. A hearing date has not been set, and is not expected before the end of 2008.

Invalidity Challenge by the ECB in Italy

Proceedings were commenced by the ECB in the District Court of Turin, Intellectual Property Specialist Division (the “Italian Court”). The parties have each submitted four “technical briefs” prepared by party-appointed technical (patent attorney) experts to a Court-appointed technical expert. The Court appointed expert has given his opinion in April 2008 that the patent is invalid for added matter. The expert reviewed the English, German and French decisions, but did not take into account the Netherlands decision. A hearing in May 2008 was held at which DSS sought to re-open the technical submissions to the court-appointed expert on the grounds that he should also consider the reasoning of the Netherlands decision. A decision on that issue is expected in mid-September 2008.

Invalidity Challenge in Belgium

The ECB brought proceedings in the Brussels Court of First Instance (“the Belgian Court”). On December 29, 2006, DSS filed a provisional infringement claim in order to protect itself with respect to the 5-year limitation period in Belgium. DSS cited the pending European Court of First Instance case and stated that it did not intend to proceed with its infringement claim in Belgium pending determination of the European Court of First Instance proceedings.

Extensive briefs (including technical expert reports) were filed in October 2006, December 2006 and April 2007. In October 2007, the ECB supplemented its arguments with further technical expert reports and (following the rejection of jurisdiction by the European Court of First Instance) requested that the invalidity and infringement cases be heard together at trial. DSS opposed the hearing of validity and infringement together. In June 2008, the Court decided that it would hear only validity arguments at the trial to be held on February 12-13, 2009. A further brief from DSS on invalidity is due to be submitted in mid-September 2008 and a final brief in January 2009. No timetable for the infringement action has been set, although it is unlikely that the trial will begin before March or April 2010. It is expected that DSS will need to formally plead its infringement case (and provide evidence) in February or March 2009.

38

Plan for Future Infringement Claims

Other than the suit filed by DSS in the European Court of First Instance in Luxembourg, DSS has not yet initiated infringement actions, with respect to the DSS Patent, in any jurisdiction covered by the DSS Patent. Prospective defendants and jurisdictions for future infringement actions have been determined and are identified in a schedule to the Litigation Agreement. Identified defendants include, among others, certain non-governmental entities. In addition to the jurisdictions where the validity of the DSS Patent is either currently under consideration or where either DSS or the ECB is appealing decisions, we have also identified ___________, __________ and __________ as jurisdictions where infringement suits may be initiated. Our Manager, in furtherance of our responsibilities under the Litigation Agreement, will determine which defendants to file infringement suits against, the nature of those suits and the jurisdictions where those suits will be filed. We anticipate that such decisions will be based on, among other things: (i) the extent of the infringement by a prospective defendant; (ii) the location of the infringing action; (iii) whether a prospective defendant is a governmental entity or a private enterprise; and (iv) the patent infringement laws of the applicable jurisdictions (i.e. choice of jurisdictions that are more plaintiff friendly).

39

SCHEDULE 11

*

40

SCHEDULE 12

*

41

SCHEDULE 13

SEC Comment Letters addressed to DSS, dated April 11, 2008, June 6, 2008, July 11, 2008 and August 13, 2008, and DSS’ responses thereto. DSS has not yet responded to the SEC Comment Letter dated August 13, 2008.

42

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Patrick White, certify that:

1.I have reviewed this quarterly report of Form 10-Q of Document Security Systems, Inc.;

2.Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f), for the registrant and we have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the registrant’s audit committee of the board of directors (or persons performing the equivalent functions);

a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

Date: November 10, 2008

/s/Patrick White

Patrick White

Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Philip Jones, certify that:

1.I have reviewed this quarterly report of Form 10-Q of Document Security Systems, Inc.;

2.Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f), for the registrant and we have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the registrant’s audit committee of the board of directors (or persons performing the equivalent functions);

a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting;

Date: November 10, 2008

/s/ Philip Jones

Philip Jones,

Acting Chief Financial Officer

(Vice President of Finance)

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO SECTION 906 OF

THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Document Security Systems, Inc. (the “Company”) on Form 10-Q for the quarter ending September 30, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Patrick White, Chief Executive Officer of the Company certify, pursuant to 18 U.S.C. section1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:

The Report fully complies with the requirements of the section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: November 10, 2008

/s/Patrick White

Patrick White

Chief Executive Officer

A signed original of this written statement required by Section 906 has been provided to Document Security Systems, Inc and will be retained by Document Security Systems, Inc and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO SECTION 906 OF

THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Document Security Systems, inc. (the “Company”) on Form 10-Q for the quarter ending September 30, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Philip Jones, Acting Chief Financial Officer of the Company, respectfully certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:

The Report fully complies with the requirements of the section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: November 10, 2008

/s/Philip Jones

Philip Jones

Acting Chief Financial Officer

(Vice President of Finance)

A signed original of this written statement required by Section 906 has been provided to Document Security Systems, Inc and will be retained by Document Security Systems, Inc and furnished to the Securities and Exchange Commission or its staff upon request.